Capital requirements set the minimum amount of capital a bank must hold to absorb losses. Capital is not cash in a vault. It is the difference between a bank's assets and its liabilities, funded by shareholders and retained earnings. Regulators require banks to hold capital equal to a percentage of their risk-weighted assets. The higher the risk, the more capital required.

The rules come from the Basel Accords. Basel III, the current framework, requires a minimum common equity tier 1 ratio of 4.5 percent, plus a capital conservation buffer of 2.5 percent, for a total of 7 percent. Systemically important banks must hold additional capital. The largest U.S. banks face even stricter requirements, with stress tests determining how much capital they need to survive a severe recession.

Capital requirements are a trade-off. Too little capital, and banks fail when losses hit. Too much, and banks lend less, slowing the economy. The 2008 crisis showed that capital levels were too low. Banks had little cushion to absorb mortgage losses, and taxpayers had to bail them out. Since then, capital levels have roughly doubled at the largest banks.

Critics argue that capital requirements are still too complex and that banks game the risk weights. Some economists propose a simple leverage ratio, requiring capital as a percentage of total assets regardless of risk. The debate continues, but the principle is settled: banks must have skin in the game.