Banking and Insurance - Laws and Practice · Risk Management in Banks and Basel Accords

Capital Adequacy Ratio and Regulatory Capital for Banks

Updated 11 October 2026 · Fact-checked

Capital adequacy is the minimum capital a bank must hold against its risk-weighted assets. CRAR = (Tier 1 capital + Tier 2 capital) ÷ risk-weighted assets × 100. To solve a question, compute eligible capital, compute risk-weighted assets (RWA) by applying risk weights, divide, and compare with the RBI minimum.

Understand Capital Adequacy and Regulatory Capital

A bank lends mostly other people's money. If some loans go bad, the loss must fall on the bank's own capital and not on depositors. Capital adequacy is the rule that the bank must hold enough own capital for the risk it takes.

Regulators do not compare capital with total assets. They compare it with risk-weighted assets (RWA). A government security carries little risk, so it gets a low weight. A risky corporate loan gets a higher weight. Off-balance-sheet items such as guarantees and letters of credit are first converted into credit equivalents and then weighted. Under Basel III, RWA also includes charges for market risk and operational risk, not only credit risk.

Regulatory capital is the capital that counts for this ratio. It has two main layers. Tier 1 capital absorbs losses while the bank is a going concern. It has Common Equity Tier 1 (CET1), made up of equity share capital, share premium, statutory reserves, free reserves and retained profit, less regulatory deductions, plus Additional Tier 1 (AT1) such as perpetual non-cumulative instruments. Tier 2 capital absorbs losses when the bank fails (gone-concern basis). It includes items such as subordinated debt meeting the conditions, revaluation reserves (at a discount) and general provisions up to a ceiling.

The ratio is called CRAR (Capital to Risk-weighted Assets Ratio), also called the capital adequacy ratio. RBI applies the Basel III framework to Indian commercial banks. Check the current RBI master circular figures before the exam. Broadly, the minimum total capital is 9% of RWA, the minimum CET1 is 5.5% and the minimum Tier 1 is 7%. A capital conservation buffer of 2.5% of RWA, in CET1, comes on top. So the effective total requirement with the buffer is 11.5%.

The key idea for the exam: Tier 2 is a supporting layer. Tier 2 counted toward capital cannot exceed what the rules allow in relation to Tier 1, so a bank cannot meet the requirement with Tier 2 alone.

Key rules to remember

CRAR: CRAR (%) = (Tier 1 capital + Tier 2 capital) ÷ Total RWA × 100; Use eligible capital after regulatory deductions and any limits on Tier 2.
Tier 1 capital: Tier 1 = CET1 + Additional Tier 1 (AT1); CET1 is mainly equity, share premium and reserves, less deductions.
Total capital: Total regulatory capital = Tier 1 + Tier 2; Tier 2 is gone-concern capital.
Risk-weighted asset (funded): RWA = Asset amount × Risk weight %; Sum across all assets to get credit-risk RWA.
Off-balance-sheet RWA: RWA = Notional amount × Credit conversion factor (CCF) × Risk weight %; CCF converts the contingent item into an on-balance-sheet equivalent.
Total RWA: Total RWA = Credit-risk RWA + Market-risk RWA + Operational-risk RWA; If the question gives only credit risk, state that assumption.
Minimum requirement (Basel III as applied by RBI): Total capital ≥ 9% of RWA; Tier 1 ≥ 7%; CET1 ≥ 5.5%; plus 2.5% conservation buffer in CET1; Quote the figures as per the RBI master circular in force. Use the figures given in the question if they differ.

How to solve Capital Adequacy and Regulatory Capital questions

Use the same sequence for any numerical or descriptive question on capital adequacy.

1Read the data and separate capital items from asset items.
2Compute Tier 1: add CET1 items and AT1, then subtract the deductions the question mentions.
3Compute Tier 2 from the eligible Tier 2 items. Apply any ceiling given in the question.
4Convert off-balance-sheet items using the credit conversion factor, then apply the risk weight.
5Multiply every asset by its risk weight and add up to get RWA. Add market and operational risk RWA if given.
6Compute CRAR = (Tier 1 + Tier 2) ÷ RWA × 100. Also compute the Tier 1 ratio if asked.
7Compare with the RBI minimum and conclude: adequate or shortfall.
8If there is a shortfall, state the capital needed: required % × RWA minus existing capital.

Quickest way: Risk-weight table method

When to use it: For numerical questions with many assets and different risk weights.

Draw a three-column list: item, amount, weight. Write the RWA beside each row.
Total the RWA column once. Do not recompute it.
Write capital as Tier 1 and Tier 2 in two lines and add.
Divide and write the ratio to two decimals.
Write a one-line conclusion against the minimum. Marks are given for it.

Common mistakes in Capital Adequacy and Regulatory Capital

Dividing capital by total assets instead of RWA.
Students confuse CRAR with a simple leverage or equity ratio.
Fix: Always build the RWA column first. The denominator is risk-weighted, not the balance sheet total.
Adding Tier 2 without checking limits or deductions.
Students treat every reserve or debt item as eligible capital.
Fix: Classify each item as CET1, AT1 or Tier 2, apply stated deductions and caps, and note your assumption.
Applying the risk weight to the notional amount of guarantees directly.
Students forget the credit conversion factor step.
Fix: Multiply by the CCF first, then by the risk weight.
Confusing Tier 1 and Tier 2 roles.
Both are called capital and the names sound similar.
Fix: Remember: Tier 1 absorbs losses while the bank continues (going concern). Tier 2 absorbs losses at failure (gone concern).
Stating the minimum ratio without the buffer or leaving it out of the conclusion.
Students remember 9% only.
Fix: Mention the 9% minimum and the 2.5% conservation buffer. Use the figure the question gives.
Writing a number with no conclusion.
Students stop after the division.
Fix: Close with whether the bank meets the requirement and the shortfall or surplus.

Worked examples

Example 1

A bank has: Tier 1 capital ₹600 crore, Tier 2 capital ₹200 crore. Its assets: cash ₹100 crore (0% weight), government securities ₹500 crore (0%), loans to corporates ₹2,000 crore (100%), home loans ₹800 crore (50%), and loans to other banks ₹400 crore (20%). Compute CRAR and compare with a 9% minimum (consider credit risk only).

Show the solution

RWA for cash = 100 × 0% = ₹0.
RWA for government securities = 500 × 0% = ₹0.
RWA for corporate loans = 2,000 × 100% = ₹2,000 crore.
RWA for home loans = 800 × 50% = ₹400 crore.
RWA for loans to banks = 400 × 20% = ₹80 crore.
Total RWA = 0 + 0 + 2,000 + 400 + 80 = ₹2,480 crore.
Total capital = 600 + 200 = ₹800 crore.
CRAR = 800 ÷ 2,480 × 100 = 32.26% (approx.).
Tier 1 ratio = 600 ÷ 2,480 × 100 = 24.19% (approx.).

Answer: CRAR is about 32.26%, well above the 9% minimum. The bank is adequately capitalised.

Example 2

A bank has RWA of ₹5,000 crore and total eligible capital of ₹480 crore. Is it meeting a 9% minimum CRAR? If not, how much additional capital is required?

Show the solution

CRAR = 480 ÷ 5,000 × 100 = 9.6%.
Required capital at 9% = 9% × 5,000 = ₹450 crore.
Capital held ₹480 crore is more than ₹450 crore, so there is a surplus of ₹30 crore.
If the 2.5% buffer applies, the requirement is 11.5% × 5,000 = ₹575 crore.
Against that, capital falls short by 575 − 480 = ₹95 crore.

Answer: The bank meets the 9% minimum (CRAR 9.6%, surplus ₹30 crore). If the 2.5% capital conservation buffer is also counted (11.5%), it is short by ₹95 crore.

Exam tips

Show the RWA table clearly. Marks are given for method even if the final division is slightly off.
State the formula first, then the figures, then a conclusion against the RBI minimum.
In theory questions, give a short table-like comparison in bullets for Tier 1 versus Tier 2: role, components, loss absorption.
State your assumptions, such as credit risk only or no deductions, when the question is silent.
Link the answer to Basel III and RBI by name, and mention that the minimum figures are as per the RBI circular in force.

Practice questions from Risk Management in Banks and Basel Accords

Capital Adequacy and Regulatory Capital in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Capital Adequacy and Regulatory Capital: frequently asked questions

What is the difference between Tier 1 and Tier 2 capital?

Tier 1 is core capital that absorbs losses while the bank keeps operating. It has equity, reserves and Additional Tier 1 instruments. Tier 2 is supplementary capital, such as eligible subordinated debt, that absorbs losses when the bank fails.

How do I calculate CRAR in a bank?

Add Tier 1 and Tier 2 capital after deductions. Compute RWA by multiplying each asset, and converted off-balance-sheet item, by its risk weight. Divide capital by RWA and multiply by 100.

What is the minimum CRAR for Indian banks?

Under RBI's Basel III norms, the minimum total capital is 9% of RWA, with a further 2.5% capital conservation buffer. Always check the latest RBI master circular, and use the figures given in the question.

Why are risk weights used instead of total assets?

Assets carry different levels of risk. Risk weights make a bank with risky assets hold more capital than a bank with safe assets of the same size.