IMF

Capital Adequacy Ratio

The episode of “The Economy, How Do You Measure That?” breaks down the capital adequacy ratio (CAR), the benchmark that regulators use to gauge a bank’s ability to absorb losses and protect depositors. CAR is calculated by dividing a bank’s regulatory capital—primarily Tier 1 equity and retained earnings, plus Tier 2 subordinated debt—by its risk‑weighted assets, which assign higher weights to riskier loans. A simple example shows a bank with $10 million of regulatory capital and $100 million of risk‑weighted assets yields a 10 % CAR, comfortably above the Basel III minimum of 8 % and any national buffers. The hosts cite the 2007‑08 crisis, Northern Rock, and the 2023 Silicon Valley Bank collapse as vivid reminders that low CAR can spark runs and systemic panic. They also highlight the Basel framework’s tiered capital definitions and the “trapeze‑artist” analogy that illustrates how capital cushions a bank when assets sour. For policymakers, CAR is a trigger for supervisory actions, ranging from capital‑raising mandates to outright closure, and it enables cross‑country comparisons of financial stability. For consumers, a robust CAR means greater confidence that deposits are safe, reinforcing the overall resilience of the banking system.