Greg Nowell's brief tutorial on the banks was spot on. A few brief additions & comments
1. "Capital is a liability side item" -- I used to drum this phrase into baby bank regulators. The very best way to think of bank capital is, as GN said, as the money ponied up by the people who founded the bank. However, in supervisory slang, it is also used to refer to the instruments which that capital is invested in. I've never yet met a financial journalist who really understands this point.
2. As a bank goes on, it (usually) makes profits, which are either paid out as dividends, or retained in the bank. Retained earnings are also capital.
3. All of the above refers to "Tier One" capital -- equity, or "proper capital". However, the Basle 8% refers to the ratio between risk assets and "total capital". Total capital includes preference shares ("preferred stock" to the Yanks), subordinated debt, convertibles, and other "equity-like" instruments. You can generally judge the health of a nation's banking system by looking at the kind of grunge they allow to be capital instruments.
4. But what the hell are "risk assets"? (more related to the original question). It's shorthand for "Risk Weighted Assets" When you're reviewing a bank's accounts as a regulator, you take the assets, and then "weight" them according to a set of rules based on the following:
Zone A government bonds (basically OECD members who have not rescheduled debt in the last five years) -- 0% (hence Doug's comment)
Cash, deposits with central banks, anything guaranteed by a Zone A government, gold -- 0%
Interbank deposits, municipal governments -- 20%
First charge residential mortgages -- 50%
Basically everything else -- 100%
Divide the capital by this new figure, and you have your "Cooke Ratio", "Basle ratio" or just "capital ratio".
5. I'd note that this only refers to the credit risk regulations, and that banks also have to have capital against the market risk (prices of tradeable securities) which they hold. Thus, a 30 year T-Bond strip is a "zero-weghted" asset, but you will still have to hold capital against it because of the interest rate risk. But that may be a subject for the future.
dd (ex BoE; your mileage may vary, so consult your local regulator)
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