Capital Adequacy

Capital adequacy provides regulators with a means of establishing whether banks and other financial institutions have sufficient capital to keep them out of difficulty. Regulators use a Capital Adequacy Ratio (CAR), a ratio of a bank’s capital to its assets, to assess risk. The two most important measures of capital adequacy are those specified by the Basel Committee of the Bank for International Settlements. The Basel Capital Accord, which came into effect in 1992, requires banks to have capital equal to a minimum of 8% of their assets. New rules, known as Basel II, were proposed in 2004, and are designed to improve public supervision of banks, reduce the chances of disastrous failures, and strengthen the stability of the overall financial system. Critics have argued that the proposed regulations could make banks more risk-averse, forcing many to cut lending to emerging economies and smaller companies. However, in July 2009, and in the wake of the international financial crisis, EU finance ministers agreed to adopt the proposals. The United States and many other countries are also adopting Basel II.

Best Practice

Capital Structure: A Strategy that Makes Sense

Checklists

Calculations

Dictionary

capital adequacy ratio

Capital Adequacy