Capital adequacy ratio
), also called
Capital to Risk (Weighted) Assets Ratio
toensure that it can absorb a reasonable amount of loss and are complying with their statutoryCapital requirements.This ratio is used to protect depositors and promote the stability andefficiency of financial systems around the world.
A set of agreements set by the Basel Committee on Bank Supervision (BCBS), which provides recommendations on banking regulations in regards to capital risk, market risk andoperational risk. The purpose of the accords is to ensure that financial institutions haveenough capital on account to meet obligations and absorb unexpected losses.The first Basel Accord, known as Basel I, was issued in 1988 and focuses on the capitaladequacy of financial institutions. The capital adequacy risk, (the risk that a financialinstitution will be hurt by an unexpected loss), categorizes the assets of financial institutioninto five risk categories (0%, 10%, 20%, 50%, 100%). Banks that operate internationally arerequired to have a risk weight of 8% or less.The second Basel Accord, known as Basel II, is to be fully implemented by 2015. It focuseson three main areas, including minimum capital requirements, supervisory review and marketdiscipline, which are known as the three pillars. The focus of this accord is to strengtheninternational banking requirements as well as to supervise and enforce these requirements.
Capital adequacy ratios ("CAR") are a measure of the amount of a bank'score capital expressed as a percentageof itsassetsweightedcredit exposures.
Capital adequacy ratio is defined asTIER 1 CAPITAL -A)Equity Capital, B) Disclosed ReservesTIER 2 CAPITAL -A)Undisclosed Reserves, B)General Loss reserves, C)Subordinate TermDebtswhereRisk can either be weighted assets() or the respective national regulator's minimum
total capitalrequirement. If using risk weightedassets,
≥ 10%.The percent threshold varies from bank to bank (10% in this case, a common requirement for regulators conforming to theBasel Accords) is set by the national banking regulator of different countries.