Crash Course: What Is Capital Adequacy Ratio?

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You have heard about the takeover of Skye Bank PLC by the Central Bank of Nigeria, CBN for not meeting the apex bank’s capital adequacy ratio, CAR benchmark of 10%.

But not everyone has a grasp of what CAR is.

With less jargon, CAR also known as Capital to Risk (Weighted) Assets Ratio(CAR), is the ratio of a bank‘s capital to its risk. The CBN track all bank’s CAR to ensure that they can absorb a reasonable amount of loss and complies with statutory capital requirements.

It is a measure of a bank’s capital. It is expressed as a percentage of a bank’s risk weighted credit exposures.

This ratio is used to protect depositors and promote the stability and efficiency of financial systems around the world.

Two types of capital are measured: tier one capital, which can absorb losses without a bank being required to cease trading, and tier two capital, which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors.

The CBN had warned all banks to upgrade their CAR or be taken over by the apex bank. Skye Bank might not be distressed, but the banks low CAR is a threat to its short to medium existence as a going concern.

Next time you are looking at the financial statement of a bank, do not just look at its net profit, look at its CAR, it is a critical sign of a bank’s ability to withstand impairments and other systemic shocks.


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