Capital Adequacy Ratio - A comparative analysis

Introduction

CAPITAL ADEQUACY RATIO (CAR)

CAR is a measure of the bank’s capital expressed as a percentage of its risk weighted credit exposures. A minimum CAR ensures that the bank can absorb certain amount of losses before becoming insolvent. Thus minimum CAR ensures the stability and efficiency of the financial system. Minimum CAR also gives some protection to the depositors. In the event of a winding-up, depositors’ funds rank in priority before capital, so depositors would only lose money if the bank makes a loss which exceeds the amount of capital it has. The higher the CAR, the higher is the level of protection available to depositors.

One of the most important principles of BIS formulated “Core principles of Effective Banking Supervision” is that the banks should never be allowed to fail and for that it is essential that corrective action should be taken while the bank still has a manageable cushion of capital. This can be effectively tracked through the CAR re...