What is Capital Adequacy Ratio?

Описание: Capital Adequacy Ratio (CAR) is a fundamental metric within the banking sector, playing a crucial role in safeguarding financial stability. It represents the level of capital a bank maintains to mitigate its inherent risks, with this capital serving as a critical buffer in the event of financial turmoil. CAR is expressed as a percentage of the institution's risk-weighted assets, providing a clear indicator of its resilience. The capital structure of a bank is divided into two essential components, Tier 1 and Tier 2 Capital. Both tiers are meticulously designed to shield the bank from the impact of a crisis, which could potentially threaten its ongoing operations. However, each tier of capital fulfills a distinct purpose when the bank faces losses or an increase in the risk to its financial stability. Calculating CAR for a financial institution involves a straightforward formula: the combined Tier 1 and Tier 2 capital is divided by the risk-weighted assets. This equation offers a precise measure of a bank's ability to withstand adverse financial conditions. Tier 1 capital comprises Common Equity Tier 1 (CET1) and Additional Tier 1 Capital (AT1). Under the Basel III framework, as stipulated by the Basel Committee, banks are mandated to maintain a CET1 capital of at least 4.5%. When AT1 capital is included, the Tier 1 Capital should exceed 6%, underlining the importance of robust capital reserves. Furthermore, regulatory standards dictate that the sum of capital instruments held by banks, encompassing both Tier 1 and Tier 2 capital, must meet a minimum threshold of 8%. It's noteworthy that AT1 capital for institutions may include perpetual contingent convertible instruments, while CET1 capital consists of pure common equity. In summary, CAR is the bedrock of financial stability within the banking sector, with its two-tiered capital structure serving as a safety net to protect against financial shocks and maintain the continuity of essential banking services.

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