Liquidity ratios and capital ratios and how they affect the stability of a financial institution
Regulators force banks to hold minimum levels of liquid assets and own capital. These rules reduce the risk of a bank collapsing when borrowers default or depositors demand their money back.
Formula
Liquidity Ratio = Liquid Assets / Total Assets; Capital Ratio = Tier 1 Capital / Risk-Weighted Assets
Real World
After the 2008 crisis, Basel III rules forced Barclays to raise its core Tier 1 capital ratio from around 5% to above 12%, forcing it to shrink its investment banking division and raise new equity.
Exam Focus
Distinguish liquidity (can you pay now?) from solvency (do assets exceed liabilities?) — confusing the two is a common exam error.
Price Elasticity of Demand
PED = % change in quantity demanded ÷ % change in price
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