McDonough Ratio

For this one, we have to start with a little trip back to the 1970s, a time of smiley-face buttons, bell bottoms, and the death rattle of rock n' roll. It's 1974. The world's biggest central banks establish the Basel Committee on Banking Supervision, a group meant to encourage communication over things like banking regulation and worldwide economic matters.

Now we'll skip ahead in time a few decades. The key takeaway from the Basil Committee (at least for our purposes here) is that they hosted a series of conferences over the next several decades aimed at creating universal banking standards. These meetings got named like early Led Zeppelin albums: Basel I, Basel II, and Basel III.

The McDonough Ratio comes out of Basel II, which took place in 2004.

The math behind the ratio is too complicated to get into without forcing you to take some graduate-level business courses. But speaking in generalities, it provides a way to test whether a bank has enough capital. It's like a check of a bank's balance sheet, seeing whether the institution has enough access to cash, compared to the level of risk posed by its outstanding loans and other investments.

The McDonough system updates what was called the Cooke ratio, itself a result of Basel I. The McDonough version made certain tweaks, including a new way of computing risk-weighted assets.