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Capital adequacy in its simplest terms is the requirement of the capital(equity) which any lending agency faces as per the norms of the said country/ies. This norm is put to prevent indiscriminate lending by the companies to the borrowers or lending to an extent which is not backed by the fundamentals of the lending agencies. Now lets understand what exactly it is...
Say a bank lends Rs 1 crore to a borrower which does not give any collateral in that case the risk which bank undertakes is of Rs 1 crore full as he is not secured. Now if the banks portfolio consists of only such unsecured loans of 100 crores then to meet the capital adequacy requirement the bank would have to have a equity capital of Rs 10 crores i.e 10 of the risky assets.
In short for all the risky loans which a banks makes it should have a backing of equity capital. At present the RBI requirement is 9% but it would go up to 12% from 2004. Risk calculation in the loans made is done as per the norms of the RBI.
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