The capital adequacy ratio (CAR) measures a bank's capital in relation to its risk weighted assets and off-balance sheet exposures. CAR is expressed as a percentage calculated as Total Capital/Risk Weighted Assets. It helps regulators ensure banks can absorb losses to protect depositors and promote stability. Tier 1 capital consists of common stock and reserves, while Tier 2 includes preferred stock and subordinated debt. National regulators monitor banks' CAR to comply with minimum capital requirements.
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The capital adequacy ratio (CAR) measures a bank's capital in relation to its risk weighted assets and off-balance sheet exposures. CAR is expressed as a percentage calculated as Total Capital/Risk Weighted Assets. It helps regulators ensure banks can absorb losses to protect depositors and promote stability. Tier 1 capital consists of common stock and reserves, while Tier 2 includes preferred stock and subordinated debt. National regulators monitor banks' CAR to comply with minimum capital requirements.
The capital adequacy ratio (CAR) measures a bank's capital in relation to its risk weighted assets and off-balance sheet exposures. CAR is expressed as a percentage calculated as Total Capital/Risk Weighted Assets. It helps regulators ensure banks can absorb losses to protect depositors and promote stability. Tier 1 capital consists of common stock and reserves, while Tier 2 includes preferred stock and subordinated debt. National regulators monitor banks' CAR to comply with minimum capital requirements.
Copyright:
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Download as DOCX, PDF, TXT or read online from Scribd
The capital adequacy ratio (CAR) measures a bank's capital in relation to its risk weighted assets and off-balance sheet exposures. CAR is expressed as a percentage calculated as Total Capital/Risk Weighted Assets. It helps regulators ensure banks can absorb losses to protect depositors and promote stability. Tier 1 capital consists of common stock and reserves, while Tier 2 includes preferred stock and subordinated debt. National regulators monitor banks' CAR to comply with minimum capital requirements.
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CAPITAL ADEQUACY RATIO
A measure of a bank's capital. It is expressed as a percentage of a bank's risk weighted
Also known as "Capital to Risk Weighted Assets Ratio (CRAR)."
Capital adequacy ratio is the ratio which determines the capacity of the bank in terms of meeting the time liabilities and other risks such as credit risk, operational risk, etc. In the most simple formulation, a bank's capital is the "cushion" for potential losses, which protects the bank's depositors or other lenders. Banking regulators in most countries define and monitor CAR to protect depositors, thereby maintaining confidence in the banking system.
Tier 1 capital is the core measure of a bank's financial strength from a regulator's point of view. It is composed of core capital, which consists primarily of common stock and disclosed reserves (or retained earnings), but may also include non-redeemable non- cumulative preferred stock.
Both Tier 1 and Tier 2 capital were first defined in the Basel I capital accord and remained substantially the same in the replacement Basel II accord. Tier 2 capital is senior to Tier 1, but subordinate to deposits and the deposit insurer's claims. These include preferred stock with fixed maturities and long-term debt with minimum maturities of over five years.
Basel Committee for Bank Supervision (BCBS) has prescribed a set of norms for the capital requirement for the banks in 1988 known as Basel Accord I.
It is a ratio of a bank's capital to its risk. National regulators track a bank's CAR to ensure that it can absorb a reasonable amount of loss and complies with statutory Capital requirements.
This ratio is used to protect depositors and promote the stability and efficiency of financial systems around the world.
Two types of capital are measured:
Tier one capital, which can absorb losses without a bank being required to cease trading, and Tier two capital, which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors.
Total Capital: constitutes of Tier I Capital and Tier II Capital less shareholding in other banks. Tier I Capital = Ordinary Capital+Retained Earnings& Share Premium - Intangible assets. Tier II Capital = Undisclosed Reserves+ General Bad Debt Provision+ Revaluation Reserve + Subordinate debt+ Redeemable Preference shares.
Basel Committee has revised the guidelines in the year June 2001 known as Basel II Norms.
There are Three Pillars of Basel Accord II.
1.Minimum Capital Requirement: Based on certain calculations minimum capital requirement has to be maintained. 2.The Supervisory Review Process: The Central Bank (RBI) of the country has to ensure that each bank has an adequate capital to adopt better management techniques. 3.Market Discipline: There should be a mandatory disclosure on risk management practices with transparency.
Risk weighting
Risk-weighted assets are the total of all assets held by the bank weighted by credit risk according to a formula determined by the Regulator (usually the country's central bank).
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 RBI 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 the credit conversion factor. This will then have to be again multiplied by the relevant weightage.
Local regulations establish that cash and government bonds have a 0% risk weighting,
and residential mortgage 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.
Other loans: 50 units.
Other assets: 5 units. Bank "A" has debt of 95 units, all of which are deposits.
Bank A's risk-weighted assets are calculated as follows
CAR is helpful to check the strengthen the soundness and stability of the banking system. This ratio shows unbiased due to RBI has fixed the % of Tier I Capital and Tier II capital
{Tier I Capital should at no point of time be less than 50% of the total capital. This implies that Tier II cannot be more than 50% of the total capital. }
It is helpful to determine the capacity of the bank to pay liabilities on the time. This ratio also indicate the capacity of bank to suffer credit risk, operational risk, etc. Monitor CAR is helpful to protect depositors.
Minimum requirements of capital fund in India:
* Existing Banks 09 % * New Private Sector Banks 10 % * Banks undertaking Insurance business 10 % * Local Area Banks 15%
Tier I Capital should at no point of time be less than 50% of the total capital. This implies that Tier II cannot be more than 50% of the total capital.
