What financial ratio for banks is calculated as (Tier 1 capital plus Tier 2 capital) divided by risk-weighted assets?

The bank ratio calculated as Tier 1 capital plus Tier 2 capital divided by risk-weighted assets is the capital adequacy ratio (CAR), also called the capital-to-risk-weighted-assets ratio.

CAR tests whether a bank has a sufficient capital cushion relative to the risks of its assets and certain off-balance-sheet exposures. Risk-weighted assets give safer exposures lower weights and riskier loans or investments higher weights, so the denominator is not simply the bank’s total assets.

Tier 1 capital is the stronger loss-absorbing layer, including high-quality common equity and retained earnings. Tier 2 capital can absorb losses but is generally less permanent or less protective, especially in a winding-up. Regulators therefore impose separate requirements for common equity and Tier 1 capital as well as total capital.

The framework became internationally prominent with the Basel I agreement of 1988, which established an 8% minimum total-capital benchmark against risk-weighted assets. Basel III retained the total-capital concept but added stronger quality requirements and capital buffers. CAR is not the same as the Tier 1 leverage ratio, which uses a non-risk-weighted exposure measure.