Capital Adequacy Ratio (CAR)

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Definition of 'Capital Adequacy Ratio (CAR)'

The capital adequacy ratio (CAR) is a measure of a bank's financial health. It is calculated by dividing a bank's capital by its risk-weighted assets. The higher the CAR, the more financially secure the bank is considered to be.

The CAR is a regulatory requirement for banks in most countries. The Basel Committee on Banking Supervision, an international organization that sets standards for the banking industry, recommends that banks maintain a CAR of at least 8%.

There are two main components of the CAR: Tier 1 capital and Tier 2 capital. Tier 1 capital consists of common stock, preferred stock, and retained earnings. Tier 2 capital consists of subordinated debt, general loan loss reserves, and certain other assets.

The risk-weighted assets of a bank are the assets that are considered to be the most risky. These assets include loans, securities, and off-balance sheet items. The risk-weights assigned to these assets are based on their perceived riskiness.

The CAR is a important tool for regulators to monitor the financial health of banks. A low CAR can indicate that a bank is taking on too much risk, which could lead to a financial crisis. A high CAR can indicate that a bank is too conservative and is not taking advantage of profitable opportunities.

The CAR is a dynamic measure that is constantly changing as banks' assets and liabilities change. Regulators may adjust the CAR requirement in response to changes in the economic environment.

The CAR is a useful tool for investors to assess the financial health of banks. A high CAR indicates that a bank is more likely to be able to withstand financial shocks. However, investors should also consider other factors when evaluating a bank, such as its profitability and its management team.

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