Just like we need an adequate supply of capital in our normal lives (you know, cash to pay our bills, etc.), banks need to have an adequate supply in order to make loans and pay out interest to their customers. It's also rather important to have cash on hand when a customer wants to withdraw money from their account (Think: It's A Wonderful Life).
The capital adequacy ratio (CAR) is a key metric for banks. It measures the amount of available capital as a percentage of risk-weighted credit exposure (in other words, risky loans). The figure is used to protect depositors and ensure the viability of the banking system.
The ratios measure two types of capital: Tier 1 and Tier 2 (sounds like a Dr. Seuss book). Tier 1 capital is the type that is easily available and can absorb losses without the bank having to cease operating. Tier 2 capital can cushion losses if the bank is in the process of closing (winding up) and all the Tier 1 capital is gone.
To calculate the CAR, simply add Tier 1 and Tier 2 capital and divide by "risk weighted assets" (the bank's assets such as outstanding loans weighted according to risk.) This helps auditors check to see if there will be enough cash on hand so customer deposits are not lost if the bank fails. The higher the ratio, the safer a customer's deposits will be, while the minimum ratio that banks must maintain is only 8%.
Related or Semi-related Video
Finance: What is a Current Asset?16 Views
Finance, a la shmoop. What is a current asset? Current yeah it's kind of a [Picture of a currant on a plant]
socialist raisin there, you know they all look about alike but that's a [Soldiers marching in front of Stalin with currants for heads]
currant and has nothing to do with current as cur-rent remember it like
your rent comes due soon, you rent a place for a year or less usually or at [Guy sticks his head out of pile of overdue bills]
least that's how long, you know lock in your rental rate. So if your [Someone signing a contract]
asset is current then it can be turned into cash within a year. That's how we
remember it here around Shmoop. Examples? A bond coming due in a year or less. [Bond document]
Companies store their cash all the time in short term paper like certificates of
deposit or Bank CDs which come due in less than a year. that's a current asset. [List of short-term paper]
And companies buy these kinds of bonds so they get a little more interest than
from their banks you know checking account. They buy stocks as well, shares [New interest rate is very small]
of goog can be easily converted into cash quickly. Shares in Google are a [Current asset stamp]
current asset. Ounces of gold, yep easily a current asset. All right you get the
idea, so what's not current well fourteen thousand acres of solar panel land that [Huge fields full of solar panels]
your company owns. If you ever had to sell it while there are very few buyers
and it likely would take more than a year just to figure out all the [Calendars popping up]
regulatory restrictions on selling it. A big old factory well can't sell that on [Red cross appears on a factory]
Amazon or Ebay, definitely not current. Your brand equity
in your corporation like the relationship you've developed with your
consumers, yeah it's another non-current asset you can't exactly go to the bank [Guy going up to the bank and pleading]
and convert brand loyalty to USD. So that's it current assets they live here [Arrow pointing to current assets on a balance sheet]
on this side of the balance sheet way up top in the good view seats high on the [Current assets in a tree]
vine of the tree. So put down those currants, stop ranting about the [Stalin holding a currant]
proletariat and for God's sake just buy some raisins. [Guy pointing to a box of raisins]
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