Business, Legal & Accounting Glossary
Capital adequacy ratio (CAR), also known as Capital to Risk (Weighted) Assets Ratio (CRAR) is a measure of bank’s capital against risks. It is calculated as a ratio of a bank’s net capital to its risk factors involved. In other words, Capital adequacy ratio can be determined as a percentage of a risk-weighted against credit coverage of a bank.
In simple terms, CAR can be expressed as a measure of the amount of capital present in a bank. It is expressed as a percentage of its credits that are risk-weighted.
Capital adequacy ratio (CAR) can be defined in a formula as:
Here, Risk can be expressed in two ways, it can either be weighted assets () or can be respective national regulator’s least possible total capital requirement. Capital measured here is of two types tier one capital and tier two capital. Tier one capital posses the ability to absorb losses without compelling the bank to stop transactions. Tier two capital can take up losses even in the event of closing down the bank.
Thus, Capital adequacy ratio (CAR) can be defined in a better way as:
In a balance sheet of any bank, there are three sides: asset, liability and equity. On the asset side, there is a list of loans and other assets that the bank intends to keep on hold. The assets kept on hold involve a certain degree of risks of getting misused. Different categories of bank assets are then assigned various degrees of risk weightage, which is a measure of total credit available for the risk factor. This is the measurement of CAR. Each bank needs to reserve a certain amount of credit for its risk assets. The minimum amount of CAR as declared by the Banking Ordinance is 8 per cent.
We have several instances were economy has failed due to the crumbling of financial institutions. Through Capital adequacy ratio (CAR), any financial institution has kept some fund to aid them in time of crisis.
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This glossary post was last updated: 28th March, 2020 | 5 Views.