When we speak of capital ratio, we are referring to the capital ratio of a bank. This concept tries to measure the financial health of a booth, putting in relation the funds with which it has to be able to face the unforeseen events that may arise. In this way, the risk assumed is that which arises from the assets on the bank's balance sheet.
To be able to demonstrate your solvency, banks are obliged to maintain a percentage of capital in relation to the risky assets in their possession.
How is the capital ratio calculated?
In order to calculate this ratio, we must apply the following formula:
CR = Capital Base / Risk-weighted Assets
The basic capital is the sum of the own funds, reserves, minorities and retained earnings. That is, the capital base is the part of the profit that has not been distributed as a dividend among its shareholders. Some other element that is included in this concept serves so that the bank has the capacity to absorb losses in the event that it fails (bonds that are convertible into shares, for example).
If other concepts were added to this basic capital term, we would get to obtain the capital base, which is used to calculate the total capital.
On the other hand, we have the risk-weighted assets that serve to weight the risk assets that a bank has based on the risk to which they are subjected, and thus be able to demand from the asset the amount of capital that a bank should have, in its defect.
Some assets are much safer than others, thus requiring less capital. A clear example is the mortgage that is requested to buy a house, versus a personal loan for anything else. A bank weighting factor will indicate how much risk an asset has.