Consider the following statements : 1. Capital Adequacy Ratio (CAR)

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 ?

[amp_mcq option1=”1 only” option2=”2 only” option3=”Both 1 and 2″ option4=”Neither 1 nor 2″ correct=”option1″]

This question was previously asked in

UPSC IAS – 2018

The correct option is A because statement 1 provides a largely accurate description of Capital Adequacy Ratio (CAR), while statement 2 is incorrect.

CAR is a crucial prudential regulation for banks, ensuring they have sufficient capital to absorb potential losses from risks like loan defaults (credit risk). This minimum ratio is set by the banking regulator, not individual banks.

Statement 1 correctly describes CAR as the ratio of a bank’s capital to its risk-weighted assets, maintained to absorb potential losses, including those from account holders failing to repay dues (Non-Performing Assets or NPAs). It ensures the bank remains solvent. Statement 2 is incorrect. The minimum Capital Adequacy Ratio that banks must maintain is mandated by the central bank (like the RBI in India) based on guidelines such as the Basel norms. Individual banks may choose to maintain a higher ratio for safety, but the minimum is externally determined by the regulator.

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