I thought this would be a timely definition as our markets explode. I have seen this term used in several leading newspapers that are covering the market and the Capital restrictions that are happening in the market.
So what is a Risk-Based Capital Requirement?
It is the amount of capital (read:Money) required of a federally chartered lending institution. The requirement is based on the type of lending they do and the type of assets they have to back their loans. The more risky the asset, the more capital they are required to have on hand.
Therefore, if they were loaning money on risky mortgages, they would be required to have way more money on hand to back those mortgages if they default. Therefore, less money would be available to loan to others in order to back up the risky assets they have already posted in their loan portfolios.
This is a VERY simplified explanation, but may offer some insight into why we are in the situation we find ourselves right now in October 2008.
