There are numerous financial ratios that help determine the financial health of a company. One of the most important financial ratios, and one carefully regarded by regulators, is the capital-to-risk weighted assets ratio, or capital adequacy ratioof a bank.
This ratio measures a bank’s financial stability by measuring its available capital as a percentage of its risk-weighted credit exposure. Its purpose is to protect depositors and promote financial stability. You can calculate a bank’s capital to risk-weighted assets ratio in Microsoft Excel once you determine its tier 1 and tier 2 capital and its risk-weighted assets.
Definitions of the Variable Terms
First, let’s define our variables. A bank’s tier 1 capital is its core capital, which is used when it needs to absorb losses without ceasing its operations. It includes equity and disclosed reserves. A bank’s tier 2 capital is its supplementary capital, such as undisclosed reserves and subordinated debt. Tier 2 capital is less secure than tier 1 capital. A bank’s risk-weighted assets are its assets, weighted by their riskiness, that are used to determine the minimum amount of capital that must be held to reduce its risk of insolvency.
The Formula for the Capital-To-Risk Weighted Assets Ratio
The formula for calculating the capital-to-risk weighted assets ratio is:
Capital-To-Risk Weighted Assets = (Tier 1 Capital + Tier 2 Capital) / Risk-Weighted Assets)
Calculating the Capital-To-Risk Weighted Assets Ratio in Excel
To calculate a bank’s capital-to-risk weighted assets ratio in Excel, you start by first entering “Tier 1 Capital” and “Tier 2 Capital” into cells A2 and A3. Next, enter “Risk-Weighted Assets” into cell A4 and “Capital-To-Risk Weighted Assets Ratio” into cell A5.
Assume you want to compare the ratios between two banks, Bank A and Bank B. Enter “Bank A” and “Bank B” into cells B1 and C1. Then, enter the corresponding values for Bank A’s tier 1 capital, tier 2 capital, and risk-weighted assets into cells B2 through B4. Next, enter the corresponding values for Bank B’s tier 1 capital, tier 2 capital, and risk-weighted assets into cells C2 through C4.
Bank A’s resulting capital-to-risk weighted assets ratio is calculated by entering the formula “=(B2+B3)/B4)” into cell B5. Bank B’s resulting capital-to-risk weighted assets ratio is calculated by entering “=(C2+C3)/C4)” into cell C5.
The Bottom Line
Once an individual calculates a bank’s capital-to-risk weighted assets ratio they can use it to assess whether the bank has enough capital to take on any losses before becoming insolvent and losing depositor funds. It’s crucial for a bank to monitor this ratio so it is aware of its capital adequacy levels and is able to meet its financial obligations. If all banks adhere to this ratio and take appropriate measures, a national financial meltdown can be avoided in the event of any economic downturn. Banks with a high capital-to-risk weighted assets ratio are considered to be safe and financially stable.