Capital Adequacy Ratio (CAR) also known as Capital to Risk (Weighted) Assets Ratio (CRAR),^[1] is theratio of abank'scapital to itsrisk.National regulators track a bank's CAR to ensure that it can absorb a reasonable amount of loss and complies with statutoryCapital requirements.

It is a measure of a bank's capital. It is expressed as a percentage of a bank's risk-weighted credit exposures. The enforcement of regulated levels of this ratio is intended to protect depositors and promote stability and efficiency of financial systems around the world.

Two types of capital are measured:

• Tier 1 capital, which can absorb losses without a bank being required to cease trading; and
• Tier 2 capital, which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors.

Capital adequacy ratios (CARs) are a measure of the amount of a bank'score capital expressed as apercentage of itsrisk-weighted asset.

Capital adequacy ratio is defined as:

${\displaystyle \text{CAR}=\frac{\text{Tier 1 capital + Tier 2 capital}}{\text{Risk weighted assets}}}$

TIER 1 CAPITAL = (paid up capital + statutory reserves + disclosed free reserves) - (equity investments in subsidiary + intangible assets + current & brought-forward losses)

TIER 2 CAPITAL = A) Undisclosed Reserves + B) General Loss reserves + C) hybrid debt capital instruments and subordinated debts

whereRisk can either be weightedassets (${\displaystyle a}$) or the respectivenational regulator's minimum totalcapital requirement. If using risk weightedassets,

${\displaystyle \text{CAR}=\frac{T_1+T_2}{a}}$ ≥ 10%.^[1]

The percent threshold varies from bank to bank (10% in this case, a common requirement for regulators conforming to theBasel Accords) and is set by the national banking regulator of different countries.^[2]

Two types of capital are measured:tier one capital (${\displaystyle T_1}$ above), which can absorb losses without abank being required to cease trading, andtier two capital (${\displaystyle T_2}$ above), which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors.

Capital adequacy ratio is the ratio which determines the bank's capacity to meet the time liabilities and other risks such ascredit risk, operational risk etc. In the most simple formulation, a bank's capital is the "cushion" for potential losses, and protects the bank's depositors and other lenders.Banking regulators in most countries define and monitorCAR to protect depositors, thereby maintaining confidence in the banking system.^[1]

CAR is similar toleverage; in the most basic formulation, it is comparable to theinverse ofdebt-to-equity leverage formulations (although CAR uses equity overassets instead of debt-to-equity; since assets are by definition equal to debt plus equity, a transformation is required). Unlike traditional leverage, however, CAR recognizes that assets can have different levels ofrisk.

Since different types ofassets have differentrisk profiles, CAR primarily adjusts for assets that are lessrisky by allowing banks to "discount" lower-risk assets. The specifics of CAR calculation vary from country to country, but general approaches tend to be similar for countries that apply theBasel Accords. In the most basic application,governmentdebt is allowed a 0% "risk weighting" - that is, they are subtracted from total assets for purposes of calculating the CAR.

Risk weighted assets - Fund Based : Risk weighted assets mean fund based assets such as cash, loans, investments and other assets. Degrees of credit risk expressed as percentage weights have been assigned by the national regulator to each such assets.

Non-funded (Off-Balance sheet) Items : The credit risk exposure attached to off-balance sheet items has to be first calculated by multiplying the face amount of each of the off-balance sheet items by theCredit Conversion Factor. This will then have to be again multiplied by the relevant weightage.

Localregulations establish thatcash andgovernment bonds have a 0% risk weighting, andresidentialmortgage loans have a 50% risk weighting. All other types of assets (loans to customers) have a 100% risk weighting.

Bank "A" has assets totaling 100 units, consisting of:

• Cash: 10 units
• Government bonds: 15 units
• Mortgage loans: 20 units
• Otherloans: 50 units
• Other assets: 5 units

Bank "A" has debt of 95 units, all of which are deposits. By definition,equity is equal to assets minus debt, or 5 units.

Bank A's risk-weighted assets are calculated as follows

Cash	${\displaystyle 10\ast 0\mathrm{\%}=0}$
Government securities	${\displaystyle 15\ast 0\mathrm{\%}=0}$
Mortgage loans	${\displaystyle 20\ast 50\mathrm{\%}=10}$
Other loans	${\displaystyle 50\ast 100\mathrm{\%}=50}$
Other assets	${\displaystyle 5\ast 100\mathrm{\%}=5}$
Total risk
Weighted assets	65
Equity	5
CAR (Equity/RWA)	7.69%

Even thoughBank A would appear to have a debt-to-equity ratio of 95:5, or equity-to-assets of only 5%, its CAR is substantially higher. It is considered less risky because some of its assets are less risky than others.

TheBasel rules recognize that different types of equity are more important than others. To recognize this, different adjustments are made:

1. Tier I Capital: Actual contributed equity plus retained earnings...
2. Tier II Capital: Preferred shares plus 50% ofsubordinated debt...

Different minimum CARs are applied. For example, the minimumTier Iequity allowed by statute forrisk-weightedassets may be 6%, while the minimum CAR when includingTier II capital may be 8%.

There is usually a maximum ofTier II capital that may be "counted" towards CAR, which varies byjurisdiction.

• Capital requirement
  • Capital requirement § Common capital ratios
• Tier 1 capital
• Tier 2 capital
• Basel accords
• Tier 1 Capital Ratio
• TLAC,Total Loss Absorbency Capacity
• LR,Leverage Ratio
• NSFR,Net Stable Funding Ratio
• LCR,Liquidity Coverage Ratio

• Capital Adequacy Ratio atInvestopedia.

• Financial economics
• Financial ratios
• Capital requirement

• Articles with short description
• Short description matches Wikidata