What does the capital adequacy ratio measure?

What does the capital adequacy ratio measure?

• A. The ratio of a bank's capital to its risk-weighted assets
• B. The ratio of deposits to loans
• C. The return on equity
• D. The interest rate on loans

Answer: (A)

Capital adequacy ratio measures how much capital a bank has relative to the riskiness of its assets, indicating its ability to absorb losses and continue operating under stress. It is calculated by comparing eligible capital (primarily Tier 1 capital) to risk-weighted assets, where assets are weighted according to their credit risk. A higher ratio means a stronger cushion against potential losses, which is what regulators aim to ensure through minimum requirements. This concept focuses on safety and resilience, not on liquidity (funding from deposits versus loans), profitability (return on equity), or loan pricing (interest rates).

Capital adequacy ratio measures how much capital a bank has relative to the riskiness of its assets, indicating its ability to absorb losses and continue operating under stress. It is calculated by comparing eligible capital (primarily Tier 1 capital) to risk-weighted assets, where assets are weighted according to their credit risk. A higher ratio means a stronger cushion against potential losses, which is what regulators aim to ensure through minimum requirements. This concept focuses on safety and resilience, not on liquidity (funding from deposits versus loans), profitability (return on equity), or loan pricing (interest rates).