What is the capital adequacy ratio?
The capital adequacy ratio (CAR) shows the bank’s ability to meet its obligations. A good CAR shows that the bank can absorb the potential losses, is not under threat of insolvency, and can protect the depositors' money. The capital adequacy ratio is also known as the capital-to-risk weighted assets (CRAR).
Capital Adequacy Ratio Explained
The capital adequacy ratio (CAR) is a metric that shows how well a bank can absorb losses from its assets using its capital. It is calculated by dividing the bank's capital into two tiers: Tier 1 and Tier 2, by the total amount of risk-weighted assets. Risk-weighted assets are the bank's assets adjusted for their level of credit risk. For example, a loan to the government has zero risk, while a loan to an individual has a high risk.
The CAR is expressed as a percentage and indicates a bank's financial stability and solvency. A higher CAR means the bank has more capital to cover its risks and can withstand adverse events better than a bank with a lower CAR. A lower CAR means that the bank has less capital relative to its risks and may face difficulties meeting its obligations or surviving a crisis.
Regulators set minimum CAR requirements for banks to ensure they have enough capital to protect their depositors and the financial system. The minimum CAR requirement for banks in India under Basal-III is 8%. However, sequentially, The minimum CAR requirement for the public sector and scheduled commercial banks is 12% and 9%