Features and Calculation of CRAR

Features and Calculation of CRAR

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The ratio of a bank's available capital to the risks associated with loan disbursement is called the CAR or, the Capital Adequacy Ratio. To put it another way, a bank's Capital Adequacy Ratio is the ratio of its capital to its assets and liabilities. The Capital Adequacy Ratio, also known as the capital-to-risk weighted asset ratio (CRAR), is a credit solvency maintenance tool utilized by banking authorities to assist banks in maintaining their fiscal health. Banking controllers frequently request that banks keep and keep a specific level of their obligation openness as its resources. This rate, also known as the bank's Capital Adequacy Ratio, is expressed as a percentage. The Capital Adequacy Ratio, in layman's terms, indicates how much capital a bank has in relation to its total debt exposure.

The purpose of the Capital Adequacy Ratio - National banking regulators like the Reserve Bank of India (RBI) and international banking standards like BASEL mandate Capital Adequacy Ratios for banks to prevent them from over-leveraging and becoming debt-laden while lacking sufficient liquidity to cushion against any monetary stress. Bank regulators maintain the overall health of the banking system and enforce financial discipline among banks in this manner, safeguarding the depositor's investment. In times of financial turmoil like the global financial crisis of 2008 or the more local non-banking finance crisis of 2019, maintaining the capital-to-risk weighted asset ratio strengthens banks.

Method for calculating the Capital Adequacy Ratio - The method for calculating the Capital Adequacy Ratio is as follows: (Tier I, Tier II, and Tier III (Capital funds)) /Risk-weighted assets) A bank's Capital Adequacy Ratio is calculated by taking into account three types of capital:

• Capital of Tier I: This is the bank's asset that can assist it in absorbing any shock without ceasing operations. A bank's core capital, which includes shareholders' equity and retained earnings, is referred to as Tier-I capital.

• Capital of Tier II: In the event that it comes to a close, this is the bank's asset that can cover losses. Revaluation reserves, hybrid capital instruments, and subordinated term debt make up a bank's Tier-II capital.

• Capital of Tier III: Tier-II capital and short-term subordinated loans make up this mix.