CAR is known as the risk-weighted assets ratio in the finance sector. This ratio measures the strength of a bank’s finance by applying its capital and assets. This ratio is used in business to protect from the financial crisis of a depositor and promotes stability and the efficiency of the financial system of the country. This ratio is used to check the adequate capital of a bank for the management of a certain amount of loss.
Concept Capital Adequacy Ratio
CAR is an important factor for the measurement of the capital of the bank at a certain range of percentages. This percentage helps to resolve the matters of financial risk before that risk becomes insolvent. The CAR is calculated through Tier-1 capital and Tier-2 capital and both capitals are divided into two tiers. Tier-1 capital is the core capital of banks and is disclosed for the essential needs. Tier-2 capital is the supplementing capital that is used for the reserved purpose of banks. The bank which has a high CAR is considered as above the minimum needs for suggested solvency. The bank is also running with their preserved capacity in the fulfillment of depositors’ demand. Therefore, a high capacity of CAR brings an ability to withstand the financial downturn or the unforeseen losses of the banks.
CAR of SBI
The capital adequacy of the banks has been improved in the financial year 2021 for better planning on capital resources and the generation of internal resources of the finance sector. This property of planning ensures the risk management process that has been reflected in the reduction of the credit weighted assets and the growth of advance gross ratio. The capital adequacy position of the SBI banking sector has been improved from 13.06% to 13.74% in the month of March of 2021. This has created an increase in capital of 11.44 percent and Tier-2 capital 2.06 percent. The Indian banking sector has estimated the normal CAR with 9% and risk-weighted asset with 8%. However, RBI has established the norms for all other banks except SBI to generate that amount of percentage in their personal reservation. Government has authorized commercial banks to have to maintain 9% CAR and public sector banks need to maintain 12% CAR for a better resolving process.
Importance of the capital adequacy ratio
The CAR has major importance in the banking sector, especially in the commercial sector for maintaining the risk of the capital return. The CAR ensures the efficiency and stability of the financial systems of the nation by lowering the risk of the banks which are insolvent. Banks that have a high CAR are considered safe and likely meet the obligations of finance. This ratio helps to determine the ability to meet operational losses of the financial organizations. A higher CAR ratio ensures a stronger BFI and creates more protection for the purpose of the banking investors. The commercial banking sector needs to maintain a high amount of CAR for safety and stability. Central banks and banking regulators play an important role in the management CAR ratio and establish an appropriate measurement for each bank. CAR provides excessive leverage on the commercial sector to recover the insolvent risks of the sector. Banks can improve their CAR by increasing the levels of regulatory capital that is the numerator of the capital ratio. They also maintain their CAR by decreasing the risk related to the weighted assets. This has been indicated as the denominator of the capital ratio. It is evident that tracking over the CAR of the banks is must to determine the effectiveness of it to be sustaining around the reasonable amount of the loss.
It can be concluded that the concept of CAR is based on the capacity and stability of the financial institution. This is closely related to the safety and security of depositors in the financial organization. Commercial banks need to maintain a large amount of CAR for their internal safety and security. Commercial banks have been dependent on the business where a large amount of insolvent things await. With a high amount of CAR, they can easily accommodate the financial loss and solve the insolvent thighs. Public sector banks also maintain a minimum amount of CAR for the accommodation of the credit reserve process.