Definition
Capital Ratio is a financial metric used to determine the proportion of a bank’s or firm's capital relative to its risk-weighted assets. It measures financial strength and the ability to absorb potential losses while meeting regulatory requirements.
Why It Matters
Maintaining an adequate capital ratio is essential for financial stability. Regulators set minimum capital ratio requirements to protect depositors, reduce systemic risk, and ensure that institutions can withstand economic shocks. A higher capital ratio generally indicates a more resilient institution.
Example
A bank with $50 million in capital and $400 million in risk-weighted assets has a capital ratio of 12.5% ($50M ÷ $400M). If regulators require a minimum of 10%, this bank exceeds the requirement and is considered financially sound.