Question 9 from UPSC CSE 2018 - Economy

Question

Consider the following statements:
1. Capital Adequacy Ratio (CAR) is the amount that banks have to maintain in the form of their own funds to offset any loss that banks incur if the account-holders fail to repay dues.
2. CAR is decided by each individual bank.
Which of the statements given above is/are correct?

IASCODEX · Accepted Answer

Correct Option: A. 1 only

Strategy: Statement 1 asserts banks maintain capital to offset losses, a principle central to Capital Adequacy Ratio (CAR). Statement 2 claims individual banks determine CAR; however, CAR is regulated by external authorities like the RBI or international standards (e.g., Basel norms), not by each bank. Therefore, Statement 1 is accepted, and Statement 2 is rejected.

Key Info: The Capital Adequacy Ratio (CAR), also known as Capital to Risk (Weighted) Assets Ratio (CRAR), measures a bank's available capital as a percentage of its risk-weighted credit exposures. It serves as a critical indicator of a bank's financial health and its ability to absorb losses.

*   **Determination:** Regulators, not individual banks, establish CAR requirements to ensure solvency and resilience against operational or financial stress.
*   **Regulatory Context (India):** In India, the Reserve Bank of India (RBI) prescribes minimum CAR requirements, aligning with the Basel Committee norms (Basel I, II, III).
*   **Global Standard:** Central banks or designated regulatory authorities globally decide on minimum CAR levels to ensure uniform, safe banking practices.
*   **Compliance:** Banks must maintain a minimum portion of their own funds, including Tier 1 (core equity) and Tier 2 (supplementary) capital, relative to their risk-weighted assets. While higher CAR increases a bank's resilience, it can also limit lending capacity.

IASCODEX · Answer

Option B: 2 only

IASCODEX · Answer

Option C: Both 1 and 2

IASCODEX · Answer

Option D: Neither 1 nor 2