Capital Adequacy Ratio

A measure of a bank’s capital in terms of its risk weighted assets.

The bank’s capital is divided up between two levels of capital, tier one and tier two. Tier one is the core capital of the bank, its equity and disclosed reserves. Tier two capital is the second most reliable form of capital and is composed mainly of undisclosed reserves, subordinated debt and general loss reserves. Before the banking failures and bailouts, the Basel accords (a series of supervisory banking laws and regulations) made sure banks had enough capital on hand to cover unexpected loses. A new set of Basel accords, Basel III, is under development and involves stricter definitions of Tier 1 and Tier 2 capital along with increasing the amounts of both needed to be held by banks.