Capital adequacy denotes the financial condition of a financial institution versus the capital (equity, own funds) required to protect its liabilities against insolvency risk.
The effect of credit, market, and other risks on the institution’s financial condition is generally the main consideration when evaluating the adequacy of capital.
The types and quantity of risk inherent in an institution’s activities will determine the need to maintain capital at levels above required regulatory minimums to properly reflect the potentially adverse consequences of these risks on the institution’s capital. At a high level, the capital adequacy of an institution is rated based on, but not limited to, an assessment of the following evaluation factors:
- the level and quality of capital and the overall financial condition of the institution
- the ability of management to address emerging needs for additional capital
- the nature, trend, and volume of problem assets, and the adequacy of allowances for loan and lease losses and other valuation reserves
- Balance Sheet composition, including the nature and amount of intangible assets, market risk, concentration risk, and risks associated with non-traditional activities
- risk exposure represented by off-balance-sheet activities
- the quality and strength of earnings, and the reasonableness of dividends
- prospects and plans for growth, as well as past experience in managing growth
- access to capital markets and other sources of capital, including support provided by a parent holding company