Capital Adequacy Ratio CAR

Capital Adequacy Ratio (CAR), also known as Capital to Risk-Weighted Assets Ratio (CRAR), is a measure of a bank’s financial strength that compares its capital to its risk-weighted assets. It is a key regulatory requirement ensuring that banks maintain sufficient capital to absorb losses and protect depositors.

What Is Capital Adequacy Ratio?

CAR = (Tier 1 Capital + Tier 2 Capital) / Risk-Weighted Assets x 100

Risk-Weighted Assets (RWA) are calculated by assigning different risk weights to different types of assets:
– Cash and government securities: 0% risk weight (risk-free)
– Home loans: 35-50% risk weight
– Corporate loans: 100% risk weight
– Unsecured consumer loans: 125-150% risk weight

RBI’s CAR Requirements

Under Basel III norms, RBI requires Indian banks to maintain:
– Minimum CAR: 9% (RBI mandates an additional 0.625% above the Basel III minimum of 8%)
– Capital Conservation Buffer (CCB): 2.5%
– Effective minimum CAR including CCB: 11.5%

Public sector banks must additionally maintain CAR requirements set under their recapitalisation plans.

Why CAR Matters

– **Depositor protection**: higher capital means the bank can absorb larger losses before becoming insolvent
– **Systemic stability**: regulators set CAR floors to prevent bank failures from cascading
– **Credit rating**: banks with higher CAR get better ratings and lower borrowing costs
– **Growth constraint**: a bank with low CAR cannot grow its loan book without raising more capital

Practical Example

Bank A has Tier 1 capital of Rs 500 crore and Tier 2 capital of Rs 200 crore. Risk-weighted assets are Rs 5,000 crore. CAR = (500 + 200) / 5,000 = 14%. This exceeds RBI’s 9% minimum requirement comfortably, meaning the bank is well-capitalised.

Key Takeaways

– CAR = (Tier 1 + Tier 2 Capital) / Risk-Weighted Assets; measures a bank’s capital buffer
– RBI requires Indian banks to maintain a minimum 9% CAR (plus 2.5% conservation buffer)
– Higher CAR means the bank can absorb more losses; lower CAR is a regulatory risk
– Risk weights vary by asset type: government securities are risk-free; unsecured loans carry 100-150% weights
– CAR is the primary capital adequacy metric used by RBI to assess bank health