CRAR full form in banking stands for Capital-to-Risk Weighted Assets Ratio. However, it is also known as a bank’s Capital Adequacy Ratio. Both terms are correct.
In this article, we’re going to take a close look at what CRAR stands for, how it’s calculated, and why it’s important for depositors.
Feel free to use the table of contents to jump ahead to the sections most relevant to you.
Table of Contents
- CRAR Full Form in Banking
- How Does a Bank Calculate the Capital Adequacy Ratio?
- Frequently Asked Questions
- Ready to Explore Your Options?
CRAR Full Form in Banking
CRAR full form in banking is Capital-to-Risk Weighted Assets Ratio. Additionally, CRAR is known as CAR, the Capital Adequacy Ratio. CRAR is a measure of a bank’s regulatory capital (Tier 1 and Tier 2) divided by its risk-weighted assets. Originally introduced in 1988, CRAR is designed to protect depositors by limiting the risk that a bank can take on in relation to its most sound reserves.
How Does a Bank Calculate the Capital Adequacy Ratio?
A bank will calculate the capital adequacy ratio (CAR or CRAR) by dividing the combined value of Tier 1 and Tier 2 capital against the risk-weight assets of the bank. In other words, banks compare their most sound assets to the combined risk-weighting for their entire portfolio.
Here is a closer look at the full inputs that are used to form CRAR in banking:
Tier 1 Capital
Tier 1 capital refers to the soundest assets held by a bank, primarily being made up of a bank’s equity and retained earnings. It forms the foundation of a bank’s financial strength from a regulatory perspective. That said, internationally, regulators have some control over the specific inputs into Tier 1 capital. So, each country may be slightly different in its calculation of Tier 1 capital.
Tier 2 Capital
Tier 2 capital refers to a bank’s second tier of capital held by a bank. Not surprisingly, Tier 2 capital is higher risk than Tier 1 capital because it can take longer for a bank to liquidate. Tier 2 capital includes undisclosed reserves (e.g. not disclosed on financial statements) and (depending on the financial institution) it can also include junior securities.
Risk-weighted assets are calculated through an assessment of a bank’s portfolio of assets and loans by category. In short, this involves applying relevant risk ratings to the total value of each category of loan or asset held by the bank. This then delivers the bank’s full risk-weighted assets, which along with Tier 1 and Tier 2 capital will form a bank’s CRAR.
Who Decides the Capital Adequacy Ratio?
Capital Adequacy Ratio is broadly decided on by the Basel Committee on Banking Supervision (BCBS), which is an international supervisory body. BCBS has forty-five member organizations, including 28 central banks. Additionally, BCBS is responsible for first introducing CRAR via Basel I in 1988 and has since updated it three more times with the most recent guidance (Basel IV) beginning to roll out in January 2023. However, the implementation and to some extent calculation of CRAR is the responsibility of individual jurisdictions and their respective bank regulators.
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Frequently Asked Questions
Below are three of the most common questions we receive from people asking about CRAR. If you have further questions you would like answered, don’t hesitate to get in touch with us directly.
What Is the CRAR Formula?
The CRAR formula is a division of a bank’s Tier 1 and Tier 2 capital by its total risk-weighted assets. This formula is an expression of a bank’s stability and reflects whether a bank is able to protect depositors in a time of financial stress. The full form of CRAR is Capital-to-Risk Weighted Assets Ratio but it can also be referred to as the Capital Adequacy Ratio in banking.
What Is the Use of the Capital Adequacy Ratio in Banking?
The use of the Capital Adequacy Ratio in banking is to measure a bank’s overall financial health. The way that the Capital Adequacy Ratio (CAR) works is by combining a bank’s Tier 1 and Tier 2 capital and dividing it by the bank’s total risk-weighted assets. CAR is also known as CRAR, which in banking is Capital-to-Risk Weighted Assets Ratio in full form.
What Happens if CRAR Is High?
If CRAR is high, it means that a bank is stable. In other words, if anything happens to cause financial stress on a bank it should be able to protect deposits. On the other hand, if a bank’s CRAR is low, it means that the bank is at higher risk. In other words, the bank will have a difficult time protecting depositors during periods of financial stress.
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