A bank’s capital is defined as the difference between its assets and its liabilities. In comparison, surplus includes things like profits and loss reserves.
How Does the Legal Lending Limit Work?
Lending limits exist to promote the safety of putting your money in the national banking system. These limits also prevent banks from offering excessive loan amounts to one individual, which supports the diversification of loans. As mentioned, the standard lending limit dictates that a bank can’t lend a single borrower more than 15% of its available capital and surplus. If the borrower secures the loan with collateral, banks can lend them up to a quarter of their capital and surplus. However, certain loans are not subject to legal lending limits, including those:
To other financial institutions Arising from the discount of commercial or business paper Affiliated with a federal agency Issued due to U.S. obligations To the Student Loan Marketing Association (SLMA), also known as Sallie Mae To leasing companies and industrial development agencies
Types of Capital
Banks and other financial institutions must maintain a certain amount of money in their reserves as capital and surplus. In the U.S., these minimum requirements are set and regulated by federal laws. A bank’s capital is the difference between its assets and liabilities and represents its total net worth. This capital represents a bank’s ability to absorb losses if the bank liquidates. Bank capital is classified into three separate levels: tier 1, tier 2, and tier 3.
Tier 1
Tier 1 capital is a bank’s core reserves and primary source of funding. It is the assets a bank holds to continue providing for the needs of its customers. Tier 1 capital includes common stock, retained earnings, and preferred stock.
Tier 2
Tier 2 capital is the bank’s supplementary capital and includes things like revaluation reserves, qualifying preferred stock, and subordinated debt.
Tier 3
Tier 3 capital is the supplementary capital banks hold to support their minimum capital requirements. It includes a greater variety of short-term debt than either of the first two tiers.
