The Basel Accords determine how much equity capital - known as regulatory capital - a bank must hold to buffer unexpected losses. Equity is assets minus liabilities. For a traditional bank, assets are loans and liabilities are customer deposits. But even a traditional bank is highly leveraged (i.e., the debt-to-equity or debt-to-capital ratio is much higher than for a corporation). If the assets decline in value, the equity can quickly evaporate. So, in simple terms, the Basel Accord requires banks to have an equity cushion in the event that assets decline, providing depositors with protection.
The
regulatory justification for this is about the system: If big banks fail, it
spells systematic trouble. If not for this, we would let banks set their own
levels of equity -known as economic capital - and let the market do the
disciplining. So, Basel attempts to protect the system in much the same way
that the Federal Deposit Insurance Corporation (FDIC) protects individual
investors.