Capital Adequacy Ratio
The Capital Adequacy Ratio (CAR), also known as the Capital to Risk-weighted Assets Ratio (CRAR), measures a bank's available capital as a percentage of its risk-weighted credit exposures. It is the primary metric used by regulators, including the RBI, to assess a bank's financial strength and its ability to absorb potential losses.
The Capital Adequacy Ratio is computed by dividing a bank's total eligible capital — comprising Tier 1 and Tier 2 capital — by its total risk-weighted assets (RWA). The numerator includes high-quality equity capital (CET1), retained earnings, additional tier 1 instruments like AT1 bonds, and tier 2 instruments like subordinated debt. The denominator weights each asset class by its risk: cash and government securities attract zero or low risk weights, while corporate loans, real estate exposures, and off-balance sheet items attract higher risk weights. A bank with a large proportion of risky assets must hold proportionally more capital.
The RBI's current minimum CAR requirement for Indian banks is 11.5% (including the 2.5% Capital Conservation Buffer), higher than the Basel III global minimum of 10.5%. Additionally, Domestic Systemically Important Banks (D-SIBs) — those classified as 'too big to fail' such as SBI, HDFC Bank, and ICICI Bank — face an additional capital surcharge of 0.2% to 0.8% depending on their systemic importance bucket, raising their effective minimum CAR requirements further.
CAR became a central concern for Indian public sector banks during the NPA crisis of 2015–2019, when soaring bad loans eroded their capital bases. The government launched the bank recapitalisation programme, committing over Rs 2.11 lakh crore in capital infusion through recapitalisation bonds between 2017 and 2020, to restore the CAR of public sector banks to regulatory minimums. Banks with CAR below the minimum trigger restrictions under the RBI's Prompt Corrective Action (PCA) framework, which constrains dividend payouts, branch expansion, and loan growth — a severe blow to business momentum.
For investors, the CAR of a bank directly influences its ability to grow its loan book. A bank operating close to the minimum CAR cannot extend significantly more credit without raising fresh equity or shrinking risk-weighted assets. This 'capital constraint' is a key determinant of near-term earnings growth trajectories. Conversely, banks with strong surplus capital ratios have the flexibility to expand credit aggressively, acquire weaker institutions, or return capital to shareholders through buybacks and dividends — all positive signals for equity investors.