Capital Adequacy Ratio

Regulators require banks to hold capital in proportion to the risk of their assets. The capital adequacy ratio, also called the capital ratio, divides a bank's eligible capital by its risk-weighted assets and expresses the result as a percentage.

For example, if a bank has 60 million of eligible capital and 500 million of risk-weighted assets, its capital adequacy ratio is 12%.

Risk-weighting means riskier assets require more capital. A loan to a stable government might carry a low risk weight, while an unsecured business loan carries a higher one. This encourages banks to hold more capital when they take more risk.

International standards, developed by the Basel Committee on Banking Supervision, set minimum ratios and require additional buffers, especially for large banks whose failure could harm the wider financial system. National regulators apply these rules and may set higher requirements. A bank that falls below its required ratio may be restricted from paying dividends or bonuses and required to raise more capital. Investors and depositors watch these ratios as a sign of a bank's strength.