Question

Are banks regulated by liquidity or capital adequacy? Is this a problem?

Answer 1

Banks are regulated by capital adequacy and not liquidity. Minimum capital regulations play a central role in banking regulation. Regulators require banks to maintain capital above a certain level in order to correct incentives to make excessively risky investments. The capital adequacy ratio by the BASEL norms and this has helped in proper regulation of the banks over the years. Though the manner of determination of the capital adequacy ratio is not yet clear but this has not been a problem and has successfully helped in proper regulation of banks.