What do you understand by Capital Adequacy Ratio ? Explain the various constituents of Tier I and Tier II capitals.
Capital Adequacy Ratio (CAR) in Bank Financial Management: Understanding Tier I and Tier II Capitals
Capital Adequacy Ratio (CAR) is a crucial metric in the realm of banking that assesses a bank's financial health and its ability to absorb losses. It serves as a regulatory tool to ensure that banks maintain an adequate level of capital in proportion to their risk-weighted assets. In essence, CAR acts as a safety cushion, safeguarding depositors and the overall stability of the banking system.
Definition of Capital Adequacy Ratio:
CAR is expressed as a percentage and is calculated by dividing a bank's capital by its risk-weighted assets. The formula is as follows:
\[CAR = \frac{\text{Total Capital}}{\text{Risk-Weighted Assets}} \times 100\%\]
The Basel Committee on Banking Supervision, a global regulatory body, sets the standards for CAR through the Basel Accords. The most notable among these is Basel III, which introduces stricter regulatory requirements to enhance the resilience of the banking sector.
Constituents of Tier I Capital:
Tier I capital, also known
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