CAR (Capital Adequacy Ratio)
The Capital Adequacy Ratio (CAR) measures a bank's available capital as a percentage of its risk-weighted credit exposure, ensuring solvency against catastrophic losses.
Detailed Explanation
Enforced by Nepal Rastra Bank under the international Basel III framework, the Capital Adequacy Ratio (also known as CRAR) ensures that financial institutions maintain a sufficient cushion of core capital to absorb unexpected loan defaults without jeopardizing public customer deposits. CAR divides a bank's eligible capital (Tier 1 Core Capital plus Tier 2 Supplementary Capital) by its Total Risk-Weighted Assets (RWA). In Nepal, commercial banks must maintain a minimum Total CAR of 11.0% (including capital conservation buffers). If CAR drops below this statutory line, the bank is barred from issuing new loans and cannot distribute dividends.
Why It Matters to You
CAR determines a bank's capacity to expand its business. A bank with an 11.2% CAR cannot grow its loan book without raising fresh capital (via rights shares or debentures), whereas a bank with a 14% CAR has ample runway to disburse profitable loans.
Formula & Calculation
CAR (%) = [(Tier 1 Capital + Tier 2 Capital) / Total Risk-Weighted Assets] × 100
- Tier 1 = Common Equity Tier 1 (Paid-up capital + General Reserves)
- Tier 2 = Subordinated bonds and general provisions
- RWA = Risk-Weighted Assets across credit, market, and operational risk
If Eligible Capital = NPR 24 Arba and RWA = NPR 200 Arba, CAR = (24 / 200) × 100 = 12.0%.
Where It Is Commonly Used
- NRB regulatory compliance audits
- Debenture issuance eligibility
- Rights share issuance justifications
Key Advantages & Limitations
Key Advantages
- Guarantees systemic stability and depositor safety
- Prevents reckless over-lending
- Enforces international Basel standards
Limitations & Risks
- Forces banks to slow down lending growth during tight capital cycles
Common Misconceptions & Beginner Traps
CAR measures total cash deposits inside the bank vault.
Deposits are bank liabilities owed to customers. CAR measures the bank's OWN shareholder capital relative to the credit risk of its loan book.
Nepal Financial & Regulatory Context
NRB mandates a minimum Tier 1 ratio of 8.5% and a Total CAR of 11.0%. Banks struggling near 11.0% frequently issue multi-billion rupee subordinated debentures on NEPSE to bolster Tier 2 capital.
Real-World Practical Scenario
Bank CAR drops to 10.8% due to rapid lending growth. Total CAR falls below NRB's statutory 11.0% threshold. NRB imposes prompt corrective restrictions: loan disbursement halted. Bank management cannot declare annual dividends at AGM. Bank issues NPR 3 Arba in 10-year subordinated debentures to restore CAR to 12.3%
Compliance restored; business operations resume under regulatory green zone.