What is Capital Adequacy Ratio (CAR)?
The Capital Adequacy Ratio (CAR) is a financial metric that measures a bank’s ability to absorb losses and keep depositors safe by having enough capital buffers. It ensures banks have a cushion to manage risks and stay afloat during tough times.
About CAR:
- Measures a bank’s financial strength and risk-taking capacity.
- Required by central banks and regulators for stability.
- Higher CAR = Less likely to go insolvent.
How is Capital Adequacy Ratio (CAR) Calculated?
Tier 1 Capital + Tier 2 Capital
CAR = —--------------------------------------
Risk - Weighted Assets
Components of CAR:
- Tier 1 Capital – Core capital that absorbs losses while the bank operates (e.g., equity capital, disclosed reserves).
- Tier 2 Capital – Supplementary capital that absorbs losses in case of bank liquidation (e.g., revaluation reserves, subordinated debt).
- Risk-Weighted Assets (RWA) – Bank’s assets are adjusted for credit, operational, and market risks.
Required CAR in India:
- 12% for Indian Public Sector Banks
- 9% for Indian Scheduled Commercial Banks
Why is Capital Adequacy Ratio Important?
- Keeps Financial System Stable – Prevents banks from collapsing due to excessive risk-taking.
- Depositors’ Money Protected – Has enough capital to cover customer deposits.
- Economic Disruption Prevented – Avoids banking crises and ensures smooth banking.
- Regulatory Compliance – Required under Basel III which is the global banking standard.
Key Takeaways
A higher CAR means a safer and stronger banking system. It plays a vital role in risk management and helps regulators monitor banks’ health to prevent crises.
