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.