Quick explanation of risk-based capital rules (BASEL):
1. A bank must maintain an 8% risk-based capital ratio in order to be considered Well Capitalized under BASEL.
2. Assets on the bank’s balance sheet (Cash, Investments, Loans, etc.) are assigned to different “risk categories” based on the risk as defined by regulation. For example, Commercial Loans are assigned to the 100% risk category. Thus, a bank must carry 8% capital against its Commercial Loans in order to be considered Well Capitalized ($8 of Capital for every $100 in Commercial Loans).
3. Cash and U.S. Treasuries are assigned to the 0% risk category, so no capital is required against these “risk-free” assets on a “risk-based” basis, although capital is required to meet minimum “Leverage Ratio” requirements (not the subject of this explainer).
4. If a bank had $100 million in Total Assets, and ALL of its assets were Commercial Loans (i.e. no Cash, bitcoin or other assets), ALL assets would be in the 100% risk category so the bank would be required to hold 100% of the 8% risk-based capital requirement, or $8 million in Capital against its $100 million in Commercial Loans in order to be considered Well Capitalized.
5. Bitcoin has been assigned a 1,250% risk-based capital requirement 🤯
6. If ALL of a bank’s assets were bitcoin (i.e. no Cash, Loans or other assets), ALL assets would be in the 1,250% risk category so the bank would be required to hold 1,250% of the 8% risk-based capital requirement, or $100 million in Capital against its $100 million in bitcoin to be considered Well Capitalized.
7. This is how you arrive mathematically at the “dollar-for-dollar” risk-based capital requirement for bitcoin holdings on a bank’s balance sheet under BASEL.
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