The Capital Adequacy Ratio (CAR) is the percentage of a bank's capital to its risk-weighted assets.
It’s a measure of a bank's capital. It is expressed as a percentage of a bank's risk weighted credit exposures.
This ratio is used to protect depositors and promote the stability and efficiency of financial systems around the world. Two types of capital are measured: tier one capital, which can absorb losses without a bank being required to cease trading, and tier two capital, which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors.
Tier 1 Capital
A term used to describe the capital adequacy of a bank. Tier I capital is core capital; this includes equity capital, disclosed reserves, common stock, preferres stock.
Tier I capital is the most reliable Capital for Banks.
This is the amounts paid up to originally purchase the stock (or shares) of the Bank
Tier 2 Capital
Tier II capital is secondary/Supplementary bank capital.
There are following classifications of tier two capitals:
Undisclosed reserves,
Revaluation reserves,
General provisions,
Hybrid instruments and
Subordinated term debt.
An Asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise
Risk: The chance that an investment's actual return will be different than expected. This includes the possibility of losing some or all of the original investment. It is usually measured by calculating the standard deviation of the historical returns or average returns of a specific investment.
Risk Comprises two components: uncertainty and exposure.
Credit risk is the risk of loss due to a debtor's non-payment of a loan or other line of credit (either the principal or interest (coupon) or both.
Credit risk due to uncertainty in a counterparty's ability to perform on an obligation.
Legal risk from uncertainty due to legal actions or uncertainty in the applicability or interpretation of contracts, laws or regulations.
Market risk is the risk that the value of an investment will decrease due to moves in market factors. The four standard market risk factors are:
Equity risk or the risk that stock prices will change.
Interest rate risk or the risk that interest rates will change.
Currency risk or the risk that foreign exchange rates will change.
Commodity risk or the risk that commodity prices (i.e. grains, metals, etc.) will change.
Sometimes, a fifth risk factor is also considered:
Equity index risk, or the risk that stock or other index prices will change
Interest rate risk is the risk that the relative value of an interest-bearing asset, such as a loan or a bond, will worsen due to an interest rate increase. In general, as rates rise, the price of a fixed rate bond will fall, and vice versa
Liquidity risk is the risk that arises from the difficulty of selling an asset. An investment may sometimes need to be sold quickly. Unfortunately, an insufficient secondary market may prevent the liquidation or limit the funds that can be generated from the asset. Some assets are highly liquid and have low liquidity risk (such as stock of a publicly traded company), while other assets are highly illiquid and have high liquidity risk (such as a house).
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