why the capital adequacy ratio matters
all things considered a bank with a high capital adequacy ratio car is perceived as healthy and in good shape to meet its financial obligations car vs the solvency ratioboth the capital adequacy ratio and the solvency ratio provide ways to evaluate a company s ability to meet financial obligations however the capital adequacy ratio is applied specifically to banks and measures their abilities to overcome financial losses related to loans they ve made the solvency ratio debt evaluation metric is used to measure whether a company has enough available cash to meet its own short and long term debt obligations solvency ratios below 20 indicate an increased likelihood of default 5analysts often favor the solvency ratio because it measures actual cash flow rather than net income not all of which may be readily available to a company to meet debt obligations the solvency ratio is best used to compare debt situations of similar firms within the same industry as certain industries tend to be significantly more debt heavy than others car vs tier 1 leverage ratiothe tier 1 leverage ratio is related to the capital adequacy ratio the tier 1 leverage ratio compares a bank s core capital with its total assets it is calculated by dividing tier 1 capital by a bank s average total consolidated assets and certain off balance sheet exposures the higher the tier 1 leverage ratio is the more likely a bank can withstand negative shocks to its balance sheet limitation of using car