Capital Adequacy Ratio
The capital adequacy ratio (CAR) is a measure of a bank's ability to meet its obligations and absorb potential losses, thus protecting depositors' money. It is also referred to as the capital-to-risk weighted assets (CRAR).
Understanding the Capital Adequacy Ratio
CAR is a metric that demonstrates a bank's capacity to cover losses from its assets through its capital, divided into Tier 1 and Tier 2. This is calculated against the total amount of risk-weighted assets, which are the bank's assets adjusted for their respective credit risk levels.
The CAR, given as a percentage, shows a bank's financial stability. A higher CAR indicates that the bank is well-equipped to cover its risks and can handle adverse events better than a bank with a lower CAR. A lower CAR suggests the bank might struggle to meet its obligations or withstand a crisis.
Regulators establish minimum CAR requirements for banks to ensure they have sufficient capital to safeguard their depositors and the financial system. For instance, in India, under Basal-III, the minimum CAR requirement is 8%. However, the requirement for public sector and scheduled commercial banks is 12% and 9% respectively.