Capital Adequacy Ratio (CAR)
CAR measures the proportion of a bank's capital relative to its risk-weighted assets. It serves as a key indicator of a bank's financial resilience and capacity to absorb unexpected losses.
Formula
CAR = (Tier 1 Capital + Tier 2 Capital) / Risk-Weighted Assets x 100
Components
Tier 1 (Core Capital): Paid-up equity, retained earnings, disclosed reserves. Absorbs losses while the bank continues operating.
Tier 2 (Supplementary Capital): Undisclosed reserves, subordinated debt (maturity over 5 years), general loan-loss provisions. Absorbs losses in liquidation.
Risk-Weighted Assets: Different asset classes carry different weights. Cash with RBI carries 0%; corporate loans may carry 100% or higher.
RBI Requirements (Basel III)
| Component | Minimum |
|---|---|
| Common Equity Tier 1 (CET1) | 5.5% |
| Total Tier 1 | 7% |
| Total CAR | 9% |
| Capital Conservation Buffer | 2.5% |
Effective minimum CAR including buffer: 11.5%.
Significance
Higher CAR indicates a larger buffer for credit losses. Banks with CAR below minimums face regulatory intervention under RBI's Prompt Corrective Action (PCA) framework. Credit rating agencies monitor CAR trends when assessing banking sector stability.
Basel Accords
CAR norms globally stem from the Basel Accords developed by the Basel Committee on Banking Supervision. India has implemented Basel III, which is more stringent than the earlier Basel I and II frameworks.