What is the Full Form of RAC in Banking?
Thе Full Form of RAC in Banking is Risk Adjustеd Capital. RAC is the capital that the financial institution maintains, adjusted for the risks associated with its assets and activities. It includes calculating the risk exposure of an asset, modifying capital, and ensuring that institutions have adequate capital to bear potential losses. This risk-adjusted capital is then used in ratios, such as the Risk-Adjusted Capital Ratio, to determine whether a financial institution has enough capital to account for losses that might be incurred, thereby determining the stability and resilience of the institutions.
Undеrstanding thе Risk-Adjustеd Capital Ratio
The risk-adjusted capital ratio measures how much of the current capital resources are available to help absorb any potential economic risks or downswings. The greater the capital ratio, the more stability there is during times of economic stress. This ratio is very important because it simply measures the adequacy of an institution’s capital to face any potential losses and retain solvency under adverse economic conditions. The ratio involves the computation of the risk of each asset based on evaluating its expected performance. For example, an income-generating factory is profitable based on other factors like maintenance and operation costs; on the other hand, a financial asset like a corporate bond is assessed based on interest rates and default risks, while bank loans include loss allowance against defaults.
Calculating thе Risk-Adjustеd Capital Ratio
The first step in arriving at the risk-adjusted capital ratio is to derive the total adjusted capital, consisting of equity and near-equity instruments adjusted for their equity content. Then, find the risk-weighted assets by multiplying the value of every asset by its corresponding risk weight. This percentage indicates how much is the probability that the asset is going to retain its value rather than becoming worthless.
