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Capital Adequacy Ratio (CAR)

Definition

The Capital Adequacy Ratio measures a bank’s capital relative to its risk‑weighted assets. It ensures banks have enough cushion to absorb losses and protect depositors.

$$\text{CAR}=\frac{\text{Tier 1 Capital}+\text{Tier 2 Capital}}{\text{Risk‑Weighted Assets}}$$

Why It Matters

• Core global banking stability metric (Basel III).
• Protects the financial system from insolvency and contagion.
• Determines how much lending a bank can safely support.
• Higher CAR = stronger, more resilient bank.

Components

• Tier 1 Capital: Common equity, retained earnings — highest‑quality capital.
• Tier 2 Capital: Subordinated debt, hybrid instruments.
• Risk‑Weighted Assets: Loans and exposures adjusted for credit risk.

Interpretation

• Higher CAR: Strong capital buffer, lower risk.
• Lower CAR: Vulnerability to losses, regulatory pressure.
• Basel III minimums: ~10.5% including buffers (varies by jurisdiction).

Example

Tier 1 + Tier 2 Capital = $50B Risk‑Weighted Assets = $400B

$$\text{CAR}=\frac{50}{400}=12.5\mathrm{\%}$$