UPSC Prelims 2018 · Question 16 of 99
UPSC Prelims 2018 question on Capital Adequacy Ratio
- ExamUPSC CSE
- Year2018
- PaperGeneral Studies Paper I
- SubjectIndian Economy
- TopicBanking
- DifficultyEasy
- TypeStatement
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?
Show answer
Answer: A. 1 only
Verdict
Only statement 1 is correct, so the answer is (a) 1 only.
Statement by statement
Statement 1 is CORRECT. The Capital Adequacy Ratio is the ratio of a bank's own capital to its risk weighted assets and current liabilities, held precisely so that losses from borrowers failing to repay are absorbed by the bank's own funds rather than by depositors.
Statement 2 is INCORRECT. CAR is decided by central banks and bank regulators, not by each individual bank. Its whole purpose is to stop commercial banks from taking excessive leverage and becoming insolvent, which a self set ratio could never achieve.
Source
Investopedia and Economic Times definitions of the capital adequacy ratio.
How to crack it
Statement 2 can be defeated by asking what the rule is for. A prudential floor that each regulated firm sets for itself is not a floor at all, so any statement letting the regulated entity choose its own prudential norm is self defeating. Apply the same test to SLR, CRR and provisioning norms. Recognising that a regulation would be pointless if the statement were true is faster and safer than recalling the Basel figure.