National regulators track a bank's CAR to ensure that it can absorb a reasonable amount of loss and complies with statutory Capital requirements.
The enforcement of regulated levels of this ratio is intended to protect depositors and promote stability and efficiency of financial systems around the world.
) or the respective national regulator's minimum total capital requirement.
above), which can absorb losses without a bank being required to cease trading, and tier two capital (
above), which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors.
[1] CAR is similar to leverage; in the most basic formulation, it is comparable to the inverse of debt-to-equity leverage formulations (although CAR uses equity over assets instead of debt-to-equity; since assets are by definition equal to debt plus equity, a transformation is required).
Unlike traditional leverage, however, CAR recognizes that assets can have different levels of risk.
In the most basic application, government debt is allowed a 0% "risk weighting" - that is, they are subtracted from total assets for purposes of calculating the CAR.
Degrees of credit risk expressed as percentage weights have been assigned by the national regulator to each such assets.
There is usually a maximum of Tier II capital that may be "counted" towards CAR, which varies by jurisdiction.