Regulatory Capital
Regulatory capital is the minimum capital a licensed financial firm must hold, and keep holding, calculated by a method the regulator prescribes rather than by ordinary accounting. It is a continuing condition of the license, tested at application and at every examination afterwards.
Also called: own funds · initial capital · minimum capital
Why it is not the same as equity
An accountant computes equity as assets minus liabilities. Regulatory capital starts from that figure and then removes what the regulator does not believe would still be there in a failure: goodwill, other intangibles, deferred tax assets, loans to owners and affiliates, and sometimes investments in subsidiaries. What remains is the capital the regulator will count. A firm can report healthy equity and still fail the test.
The method also varies with what the firm does. Some regimes fix a flat minimum by license type. Others scale the requirement with activity — a proportion of payment volume, or of electronic money in issue — and make the firm hold the higher of the two.
Different names in different places
Terminology causes most of the confusion, and the divide is not the one people expect. The United Kingdom onshored the EU payment services rules, so a UK payment institution and an EU one calculate “own funds” by the same three prescribed methods: a percentage of the preceding year’s fixed overheads; a tiered percentage of payment volume multiplied by a scaling factor; or a relevant-indicator calculation multiplied by a factor. Initial capital — what a firm must have in order to be authorized — is a separate figure from ongoing own funds.
The United States is where it genuinely diverges, and it has no single equivalent. A national bank holds regulatory capital as Basel-style ratios: common equity tier 1 of 4.5 percent, tier 1 of 6 percent, total capital of 8 percent, and a leverage ratio of 4 percent. A state-licensed money transmitter instead holds tangible net worth — aggregate assets excluding intangibles, less liabilities, determined under US accounting standards — at a level each state sets, paired with a surety bond and a permissible investments requirement. That measure sits closer to accounting equity than the own-funds methods do, which is part of why the two are so often confused.
The consequence is that a group operating in more than one place computes several different numbers from one balance sheet, and satisfying one does not satisfy another. Capital held in a UK subsidiary to meet an FCA requirement is not simultaneously available to meet a US state requirement.
In practice
Regulatory capital is calculated by a formula the regulator sets rather than taken from the balance sheet. The divide is not UK versus EU — the UK onshored the EU payment services rules, so both compute “own funds” by the same three prescribed methods. It is the United States that differs, and differs internally: a national bank holds Basel-style ratios, while a state-licensed money transmitter holds tangible net worth, a US GAAP figure adjusted for intangibles, at a level each state sets for itself.
Example
A firm reports $5 million of equity. Of that, $2.4 million is goodwill from an acquisition and $600,000 is an intercompany loan to its parent. A state applying a tangible net worth test counts $2 million. If the state requires more than that, the firm is undercapitalized on the day it files, despite audited accounts showing $5 million.
Commonly confused with
| Term | How it differs |
|---|---|
| Tangible Net Worth | Tangible net worth is the particular form regulatory capital takes in US state money transmission law; regulatory capital is the general concept across regimes. |
| Permissible Investments | Permissible investments test whether customer money in transit is covered; regulatory capital tests whether the firm’s own cushion is large enough. |
See also
- Tangible Net WorthTangible net worth is net worth with intangible assets such as goodwill stripped out. US state regulators use it as the minimum capital test a money transmitter must pass to obtain a license and to keep it, and it is computed to the state’s definition rather than the company’s.
- Surety BondA surety bond is a guarantee from a third-party surety company that a state regulator requires a money transmitter licensee to post, so consumers and the state can be paid if the licensee fails to meet its obligations. It is a guarantee the licensee buys, not money it sets aside.
- Permissible InvestmentsPermissible investments are the categories of asset a licensed US money transmitter may count against its outstanding money transmission obligations. Under the model law states have been adopting, the licensee must hold permissible investments worth at least the whole of what it owes customers, and the eligible list runs wider than cash and government securities.
- Electronic Money InstitutionA firm authorized in the United Kingdom or in an EU member state to issue electronic money and to provide payment services. The e-money it issues is a claim its holders have against the institution, redeemable at par and expressly not a deposit, which is why the funds behind it must be safeguarded.
- Payment InstitutionA payment institution is a firm authorized in the United Kingdom or a European Union member state to provide payment services — transfers, acquiring, remittance, payment initiation — but not to issue electronic money. It may hold customer funds in payment accounts used only for payment transactions; those funds are neither deposits nor e-money.