Capital Adequacy is the ability of a financial institution, such as a bank or an insurance company, to meet its financial obligations and absorb potential losses that may arise from its operations. It is the amount of capital that an institution holds as a percentage of its risk-weighted assets.

Capital Adequacy is important because it provides a measure of the financial strength and stability of an institution. It helps to ensure that an institution has sufficient capital to absorb losses and continue to operate even during difficult economic conditions. Capital Adequacy also protects depositors, investors, and policyholders from losses in the event of the institution’s failure.

The level of Capital Adequacy that is required varies depending on the regulatory requirements of each country. Regulators use various measures, such as the Capital Adequacy Ratio (CAR), to determine the amount of capital that an institution is required to hold. The CAR is calculated by dividing the institution’s capital by its risk-weighted assets, and the minimum CAR required is typically set by the regulatory authority.

Financial institutions can maintain their Capital Adequacy by retaining earnings, issuing new shares, or reducing their risk exposure. If an institution’s Capital Adequacy falls below the minimum required level, it may face regulatory sanctions, such as restrictions on its operations, or even closure.