What is the meaning of Capital Adequacy Ratio?

Capital Adequacy Ratio is also known capital-to-risk weighted assets ratio is used for the protection of depositors and promotion of stability of financial systems across the world. It is a measure of the capital of the bank which is expressed as a percentage of bank’s risk-weighted credit exposures. The ratio is usually decided by the Central banks and other bank regulators primarily to put a check on commercial banks to keep enough cushion to be able to manage reasonable losses and prevent from taking excess leverage thereby ultimately becoming insolvent.

It is calculated by the following formula:

Capital Adequacy Ratio = (Tier I + Tier II + Tier III (Capital funds)) /Risk-weighted assets