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Banks need to maintain certain minimum capital as per Basel norms but where does this money lie. If it lies in a bank account, what would happen if that bank goes bankrupt?

Say, SBI keeps its Tier1 capital in HDFC, what would happen if HDFC goes bankrupt? Or if RBI keeps it with itself, can it loan it out as per fractional reserve system?

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  • $\begingroup$ Banks usually have their “bank accounts” with their respective central bank. E.g. Deutsche Bank will probably have their “account” with the ECB. $\endgroup$
    – ssn
    Feb 22 '18 at 23:32
  • $\begingroup$ I'm voting to close this question as off-topic because it is cross-posted to the Quant stack. $\endgroup$
    – Kitsune Cavalry
    Feb 23 '18 at 23:46
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“Capital” is not an asset (as that would be on the right hand side of the balance sheet) they are long maturity instruments on the right hand side of the balance sheet.

Common equity is one major component. It’s the residual you get after you subtract all other items on the right hand side of the balance sheet from total assets - which is what forces the balance sheet to balance. (There are presumably some accounting details I am skipping over.)

If we simplify things, it’s how much more its assets are worth than its liabilities, and so it cannot get put anywhere. All that can happen is that assets it owns (a loan to another bank) can lose value, and so the credit loss reduces equity (and hence capital).

(I think perpetual preferred shares are the other major component of Tier 1 Capital. These are issued by the bank in question, and so the failure of another bank has no effect on them.)

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