Capital adequacy ratio (CAR)

also called Capital to Risk (Weighted) Assets Ratio (CRAR)[1], is a ratio of

a bank's capital to its risk. National regulators track a bank's CAR to ensure that it can absorb
a reasonable amount of loss [2] and are complying with their statutory Capital requirements.

Capital (Finance)
In a fundamental sense, capital consists of anything that can enhance a person's
power to perform economically useful work. A stone or an arrow is a capital for a
caveman who can use it as a hunting instrument. A road is a capital for inhabitants of
a city. A personal computer is a capital for a student.
In economics, capital, capital goods, or real capital are the factor of production used
to create goods or services that are not themselves significantly consumed (though
they may depreciate) in the production process. Capital goods may be acquired
with money or financial capital. At any moment in time, total physical capital may be
referred to as the capital stock, a usage different from the same term applied to a
business entity.

Liquidity Ratios

What Does Liquidity Ratios Mean?

A class of financial metrics that is used to determine a company's ability to pay off its short-
terms debts obligations. Generally, the higher the value of the ratio, the larger the margin of
safety that the company possesses to cover short-term debts.

Investopedia explains Liquidity Ratios

Common liquidity ratios include the current ratio, the quick ratio and the operating cash flow
ratio. Different analysts consider different assets to be relevant in calculating liquidity. Some
analysts will calculate only the sum of cash and equivalents divided by current liabilities
because they feel that they are the most liquid assets, and would be the most likely to be
used to cover short-term debts in an emergency.

A company's ability to turn short-term assets into cash to cover debts is of the utmost
importance when creditors are seeking payment. Bankruptcy analysts and mortgage
originators frequently use the liquidity ratios to determine whether a company will be able to
continue as a going concern.
Leverage Ratio

What Does Leverage Ratio Mean?

1. Any ratio used to calculate the financial leverage of a company to get an idea of the
company's methods of financing or to measure its ability to meet financial obligations. There
are several different ratios, but the main factors looked at include debt, equity, assets and
interest expenses.

2. A ratio used to measure a company's mix of operating costs, giving an idea of how
changes in output will affect operating income. Fixed and variable costs are the two types of
operating costs; depending on the company and the industry, the mix will differ.
Investopedia explains Leverage Ratio
1. The most well known financial leverage ratio is the debt-to-equity ratio. For example, if a
company has $10M in debt and $20M in equity, it has a debt-to-equity ratio of 0.5 ($10M/
$20M).

2. Companies with high fixed costs, after reaching the breakeven point, see a greater
increase in operating revenue when output is increased compared to companies with high
variable costs. The reason for this is that the costs have already been incurred, so every sale
after the breakeven transfers to the operating income. On the other hand, a high variable cost
company sees little increase in operating income with additional output, because costs
continue to be imputed into the outputs. The degree of operating leverage is the ratio used to
calculate this mix and its effects on operating income

Basel I (The 1988 Capital Accord)

What Does Basel I Mean?

A set of international banking regulations put forth by the Basel Committee on Bank
Supervision, which set out the minimum capital requirements of financial institutions with the
goal of minimizing credit risk. Banks that operate internationally are required to maintain a
minimum amount (8%) of capital based on a percent of risk-weighted assets.

Investopedia explains Basel I

The first accord was the Basel I. It was issued in 1988 and focused mainly on credit risk by
creating a bank asset classification system. This classification system grouped a bank's
assets into five risk categories:

0% - cash, central bank and government debt and any OECD government debt
0%, 10%, 20% or 50% - public sector debt
20% - development bank debt, OECD bank debt, OECD securities firm debt, non-OECD bank
debt (under one year maturity) and non-OECD public sector debt, cash in collection
50% - residential mortgages
100% - private sector debt, non-OECD bank debt (maturity over a year), real estate, plant and
equipment, capital instruments issued at other banks

The bank must maintain capital (Tier 1 and Tier 2) equal to at least 8% of its risk-weighted
assets. For example, if a bank has risk-weighted assets of $100 million, it is required to
maintain capital of at least $8 million.

What Does Basel Committee On Bank Supervision Mean?

A committee established by the central bank governors of the Group of Ten countries in 1974
that seeks to improve the supervisory guidelines that central banks or similar
authorities impose on both wholesale and retail banks. The committee makes banking policy
guidelines for both member and non-member countries and helps authorities to implement its
suggestions.

Basel II (initially published in June 2004)

What Does Basel II Mean?
A set of banking regulations put forth by the Basel Committee on Bank Supervision, which
regulates finance and banking internationally.
The purpose of Basel II, which was initially published in June 2004, is to create an
international standard that banking regulators can use when creating regulations about how
much capital banks need to put aside to guard against the types of financial and operational
risks banks face. dvocates of Basel II believe that such an international standard can help
protect the international financial system from the types of problems that might arise should a
major bank or a series of banks collapse. In practice, Basel II attempts to accomplish this by
setting up rigorous risk and capital management requirements designed to ensure that a bank
holds capital reserves appropriate to the risk the bank exposes itself to through its lending
and investment practices. Generally speaking, these rules mean that the greater risk to which
the bank is exposed, the greater the amount of capital the bank needs to hold to safeguard
its solvency and overall economic stability.

Investopedia explains Basel II

Basel II is the second of the Basel Committee on Bank Supervision's recommendations, and
unlike the first accord, Basel I, where focus was mainly on credit risk, the purpose of Basel II
was to create standards and regulations on how much capital financial institutions must have
put aside. Banks need to put aside capital to reduce the risks associated with its investing and
lending practices

The final version aims at:

1. Ensuring that capital allocation is more risk sensitive;

2. Separating operational risk from credit risk, and quantifying both;
3. Attempting to align economic and regulatory capital more closely to reduce
the scope for regulatory arbitrage.

While the final accord has largely addressed the regulatory arbitrage issue, there are still
areas where regulatory capital requirements will diverge from the economic.

Basel II has largely left unchanged the question of how to actually define bank capital, which
diverges from accounting equity in important respects. The Basel I definition, as modified up
to the present, remains in place.

Basel II uses a "three pillars" concept – (1) minimum capital requirements (addressing risk),
(2) supervisory review and (3) market discipline – to promote greater stability in the financial
system.

The Basel I accord dealt with only parts of each of these pillars. For example: with respect to
the first Basel II pillar, only one risk, credit risk, was dealt with in a simple manner while
market risk was an afterthought; operational risk was not dealt with at all.

The first pillar

The first pillar deals with maintenance of regulatory capital calculated for three major
components of risk that a bank faces: credit risk, operational risk, and market risk. Other risks
are not considered fully quantifiable at this stage.
Credit Risk can be calculated by using one of three approaches:
1. Standardised Approach

2. Foundation IRB (Internal Ratings Based) Approach

3. Advanced IRB Approach

IRB stands for "Internal Rating-Based Approach".

The standardised approach sets out specific risk weights for certain types of credit risk. The
standard risk weight categories are used under Basel 1 and are 0% for short term
government bonds, 20% for exposures to OECD Banks, 50% for residential mortgages and
100% weighting on unsecured commercial loans. A new 150% rating comes in for borrowers
with poor credit ratings. The minimum capital requirement (the percentage of risk weighted
assets to be held as capital) remains at 8%.

For those Banks that decide to adopt the standardised ratings approach they will be forced to
rely on the ratings generated by external agencies. Certain Banks are developing the IRB
approach as a result.

For operational risk, there are three different approaches - basic indicator approach or
BIA, standardized approach or TSA, and the internal measurement approach (an advanced
form of which is the advanced measurement approach or AMA).

For market risk the preferred approach is VaR (value at risk).

The second pillar

The second pillar deals with the regulatory response to the first pillar, giving regulators much
improved 'tools' over those available to them under Basel I. It also provides a framework for
dealing with all the other risks a bank may face, such as systemic risk, pension
risk, concentration risk, strategic risk, reputational risk, liquidity risk and legal risk, which the
accord combines under the title of residual risk. It gives banks a power to review their risk
management system.

Paid-Up Capital

What Does Paid-Up Capital Mean?

The total amount of shareholder capital that has been paid in full by shareholders.
Investopedia explains Paid-Up Capital
Paid-up capital is essentially the portion of authorized stock that the company has issued and
received payment for.

Or,
Paid up capital means the amount of capital actually paid by the shareholders
in respect of shares allotted to them.

Share Premium:
Excess amount received by a firm over the par value of its shares

Share Premium Account

What Does Share Premium Account Mean?

Usually found on the balance sheet, this is the account to which the amount of money paid (or
promised to be paid) by a shareholder for a share is credited to, only if the shareholder paid
more than the cost of the share.

Investopedia explains Share Premium Account

The share premium account may be used to issue bonus shares, write-off equity related
expenses like underwriting costs, etc.

Net worth: net worth (sometimes called net liabilities) is the total assets minus total
outside liabilities of an individual or a company.