What is ‘capital adequacy ratio’ in finance?

  • A financial metric used to gauge the ability of a bank to withstand losses without affecting its lenders and depositors.

  • While there is a variety of capital adequacy ratios, it can be calculated simply by dividing the capital of a bank by its assets. In case of heavy losses, the bank’s capital takes the first hit before the funds of lenders are affected.
  • As banks are institutions that are run mainly through borrowings, even minor losses can completely wash out its capital.
  • So the capital adequacy ratio, the most popular measure to rank bank strength, is closely monitored by both lenders and regulators.
  • In simple terms Capital Adequacy Ratio (CAR) is the ratio of a bank’s capital in relation to its risk weighted assets and current liabilities.
  • It is decided by central banks and bank regulators to prevent commercial banks from taking excess leverage and becoming insolvent in the process.


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