Banking is a heavily regulated industry, so any analysis of a bank's financial position has to include analysis of how key regulatory ratios compare to the minimum regulatory requirements and how they have moved over time.

There are four key regulatory ratios to look at.

First, we have the capital adequacy ratios.

These compare a form of regulatory capital to the bank's risk-weighted assets or RWAs.

Regulatory capital represents a solvency measure.

It's the capital a bank must hold to absorb losses it might experience from its operational activities, designed to protect depositors, creditors, and the wider financial ecosystem.

Regulatory capital in these ratios is either common equity tier one, which, on a simplified basis, is common equity and retained earnings less goodwill and other intangibles, total tier one, which includes additional tier one instruments such as contingent convertible bonds, or total capital, which adds in tier two capital, which includes, for example, subordinated debt.

The ability of each type of capital to absorb losses declines as we move through these stages, with common equity tier one having the highest loss-absorbing capacity.

These capital adequacy ratios indicate the likely ability of a bank to absorb losses and continue in business. With the higher the ratio, the better.

Risk-weighted assets takes the assets of a bank and adjusts them for their riskiness. This means that the higher the riskiness of a bank's assets, the higher the regulatory capital that needs to be held to ensure that the bank is better placed to survive given the higher risk of default.

Calculating risk-weighted assets is a complex, involved process where the level of risk of the bank's operations needs to be considered in detail.

The minimum requirement for a bank depends on a range of factors, including the size of the bank and a number of buffers that local regulators can implement, with most banks disclosing their minimum requirement within their footnotes to their financial statements.

The leverage ratio, referred to as the supplementary leverage ratio, or SLR in the US, tells a similar story to the capital adequacy ratios, but on a more simple basis by just using the total assets of a bank with no adjustment for riskiness, making this ratio more simple to apply.

From the Basel rules, the minimum for this ratio is 3%, but for US banks, the minimum requirement is 4%.

Slightly different rules are applied to larger US banks. Next, we have the liquidity coverage ratio and net stable funding ratio, which were both introduced following the 2008 global financial crisis to address the issue that most of the banks that got into financial difficulty experienced liquidity issues as much as having to hold capital to absorb losses, which is dealt with by the capital adequacy and leverage ratios. The liquidity coverage ratio compares the level of high-quality liquid assets the bank currently holds to the expected cash outflows for the next 30 days under a stressed scenario. The logic here is to understand whether a bank could continue to operate if wholesale funding markets were closed for the next 30 days, meaning the bank couldn't raise external financing so would have to fund any outflows from its existing liquid asset base for the next 30 days. High-quality liquid assets are those which can be easily and immediately converted into cash at little or no loss of value.

The net stable funding ratio takes a slightly longer-term view, the next 12 months.

The aim here is to make sure that the bank has enough funding for the next year that's already in place today, referred to as the available stable funding, to cover the funding that is needed for assets that will remain on the bank's balance sheet for at least the next 12 months, referred to as the required stable funding.

In the lead-up to the 2008 global financial crisis, some banking organizations were funding long-term assets, which required funding, with short-term liabilities, which needed to be refinanced when they reached maturity, but got into trouble when the short-term money markets dried up, or in other words, their funding was not sufficiently stable.

There are a range of available stable funding and required stable funding factors that reflect the stability of available or required funding, depending on the stability of the liabilities and assets of the bank. The required level for this ratio under the Basel rules is that it needs to be greater than one.

The key thing to remember here is that capital ratios measure solvency risk, whereas liquidity ratios measure funding risk.

Both are important, as the 2008 global financial crisis showed. Banks can be solvent but still fail due to a liquidity collapse.

For example, the fall of Silicon Valley Bank in 2023 began with a liquidity collapse, which eventually became a solvency issue.