What Is the Risk-Adjusted Capital Ratio?

The risk-adjusted capital ratio is used to gauge a financial institution's ability to continue functioning in the event of an economic downturn. It is calculated by dividing a financial institution's total adjusted capital by its 澳洲幸运5官方开奖结果体彩网:risk-weighted assets (RWA).

Understanding the Risk-Adjusted Capital Ratio

The risk-adjusted capital ratio measures the resilience of a financial institution's 澳洲幸运5官方开奖结果体彩网:balance sheet, with an emphasis on capital resources, to endure a given economic risk or 澳洲幸运5官方开奖结果体彩网:recession. The greater the institution's capital, the higher its capital ratio, which should translate to a higher probability that the entity wไill remain stable in the event of a severe economic downturn.

The denominator in this ratio is somewhat complicated, as each asset owned must be rated by its ability to perform as expected. For example, an income-producing factory is not assured to generate positive 澳洲幸运5官方开奖结果体彩网:cash flow. Positive cash flow co🌟uld depend on c🌞apital costs, plant repair, maintenance, labor negotiations, and many other factors.

For a financial asset, such as a corporate bond, profitability depends on 澳洲幸运5官方开奖结果体彩网:interest rates and the default🐬 risks of the issuer. Bank loans typically come with a l🀅oss allowance.

Calculating the Risk-Adjusted Capital Ratio

Determining total adjusted capital is the first step in figuring out the risk-adjusted capital ratio. Total adjusted capital is the sum of equity and near-e🥂quity instruments adjusted by their equity content.

Next, the value of risk-weighted assets (RWA) is measured. The value of RWA is the s♔um of each asset multiplied by its assigned individual risk. This number is stated as a percentage and reflects the odds that the asset will retain its value, i.e., not become worthless.

For example, cash and 澳洲幸运5官方开奖结果体彩网:Treasury bonds have almost a 100% chance of remaining solvent. Mortgages would likely have an intermediate risk profile, while 澳洲幸运5官方开奖结果体彩网:derivatives should have a much higher risk quotient attri꧙♔buted to them.

The final step in det꧅ermining the risk-adjusted capital ratio is to divide the total adjusted capital by the RWA. This calculation will result in the risk-adjusted capital ratio. The higher the risk-adjusted capital ratio, thಞe better the ability of the financial institution to withstand an economic downturn.

Standardization of Risk-Adjusted Capital Ratios

The purpose of a risk-adjusted capital ratio is to evaluate an institution's actual risk threshold with a higher degree of precision. It also allows comparisons across different geographical locations, including comparisons across countries.

The 澳洲幸运5官方开奖结果体彩网:Basel Committee on♐ Ba𝔍nking Supervision initially recommended these standards and regulations for banks in a document called Basel I.🍒 The recommendation was that 𝐆banks should carry enough capital to cover at least 8% of their RWA.

Basel II sought to expand the standardized rules set out in the earlier version and to promote the effective use of 澳洲幸运5官方开奖结果体彩网:disclosure as a way to strengthen markets. Basel III refined the document further, stating the calculation of RWA would depend on which version of the document was being followed.