The full form of CAR is Capital Adequacy Ratio (CAR). It is a measure of a bank’s financial strength, expressed as a percentage of its capital to its risk-weighted assets. The CAR is calculated by dividing the bank’s capital by its risk-weighted assets. Capital is the bank’s own funds, which are available to absorb losses. Risk-weighted assets are the bank’s assets that are considered to be risky. The higher the risk of an asset, the higher the weighting it will receive.
Requirements for CAR
The minimum CAR requirement is set by the banking regulator. In India, the Reserve Bank of India (RBI) requires commercial banks to maintain a CAR of 9%. Public sector banks are required to maintain a CAR of 12%.
- A high CAR is considered to be a good thing because it indicates that the bank is in a strong financial position and has enough capital to absorb losses.
- A low CAR may be a sign that the bank is taking on too much risk or that it is not managing its capital effectively.
- The CAR is just one measure of a bank’s financial health. Other factors, such as the bank’s liquidity and profitability, should also be considered.
- However, the CAR is an important tool for regulators to assess the riskiness of banks and to ensure the stability of the financial system.
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Benefits of CAR
Here are some of the benefits of having a high capital adequacy ratio:
- It protects depositors from losses in the event of a bank failure.
- It helps to ensure the stability of the financial system by preventing banks from taking on too much risk.
- It can lead to lower borrowing costs for banks, as they are seen as being less risky.
- It can make banks more attractive to investors, as they are seen as being more financially sound.
Drawback of CAR
However, there are also some potential drawbacks to having a high capital adequacy ratio:
- It can make it more difficult for banks to lend money, as they have less capital to do so.
- It can reduce the profitability of banks, as they have to hold more capital in reserve.
- It can make it more difficult for banks to compete with other banks that have lower capital adequacy ratios.
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