Explain the role of regulatory capital in managing systemic risk and how Basel III standards contribute to it.

Regulatory capital plays a crucial role in managing systemic risk by providing a buffer for financial institutions during times of stress and mitigating the potential for cascading failures across the financial system. Systemic risk refers to the risk that the failure of one financial institution could trigger a chain reaction of failures throughout the system, leading to a broader economic crisis. Basel III standards, developed by the Basel Committee on Banking Supervision, are a set of international regulations aimed at strengthening the financial system by enhancing capital adequacy, improving risk management, and promoting better liquidity. These standards contribute to managing systemic risk in several ways: 1. Higher Capital Requirements: Basel III significantly increased capital requirements for banks. This includes a higher common equity tier 1 (CET1) capital ratio, which is the core measure of a bank's financial strength. This means banks need to hold more capital relative to their assets, providing a larger cushion to absorb losses during economic downturns. For example, the minimum CET1 ratio under Basel III is 4.5%, whic....