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Q16 (IAS/2018) Economy › Money, Banking & Inflation › Banking regulation reforms Official Key

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 ?

Result
Your answer: —  ·  Correct: A
Explanation

The correct answer is option A (Statement 1 only).

**Statement 1 is correct:** CRAR is defined as the proportion of bank's total risk-weighted assets that are held in the form of shareholders' equity and certain other defined class of capital.[1] This capital serves as a buffer to offset losses when account-holders fail to repay dues. Higher the capital to risk weighted asset ratio (CRAR), higher is the safety of bank deposits.[2]

**Statement 2 is incorrect:** CAR is not decided by individual banks but is prescribed by regulatory authorities. It prescribed minimum capital requirement at 8 per cent of the Risk Weighted Assets (RWA) for banks.[1] In India's context, Under Basel-I, the RBI issued guidelines to maintain a CRAR (Capital to Risk Assets Ratio) or CAR (Capital Adequacy Ratio) of 9 per cent by every SCB.[1] This clearly shows that the central bank (RBI), not individual banks, sets the CAR requirement based on international Basel norms.

Sources
  1. [1] Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 8: Financial Market > Basel-I Norms > p. 234
  2. [2] Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > 2 Money and Banking- Part I > p. 94
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Don’t just practise – reverse-engineer the question. This panel shows where this PYQ came from (books / web), how the examiner broke it into hidden statements, and which nearby micro-concepts you were supposed to learn from it. Treat it like an autopsy of the question: what might have triggered it, which exact lines in the book matter, and what linked ideas you should carry forward to future questions.
Q. Consider the following statements : 1. Capital Adequacy Ratio (CAR) is the amount that banks have to maintain in the form of their own f…
At a glance
Origin: Books + Current Affairs Fairness: Moderate fairness Books / CA: 5/10 · 5/10
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This is a classic 'Definition + Authority' trap. Statement 1 is a standard textbook definition found in every Banking chapter. Statement 2 tests your common sense on regulation: if banks set their own safety limits, the entire concept of 'regulation' collapses. This is a Sitter for anyone who has covered Basel Norms.

How this question is built

This question can be broken into the following sub-statements. Tap a statement sentence to jump into its detailed analysis.

Statement 1
Is Capital Adequacy Ratio (CAR) the amount of a bank's own funds that must be maintained to absorb losses arising from borrowers' defaults or non-repayment?
Origin: Direct from books Fairness: Straightforward Book-answerable
From standard books
Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 8: Financial Market > Basel-I Norms > p. 234
Presence: 5/5
“• In 1988, the Basel Committee on Banking Supervision (BCBS) introduced a capital measurement system called Basel Capital Accord, also known as Basel-I. • It focused only on credit risk. • It prescribed minimum capital requirement at 8 per cent of the Risk Weighted Assets (RWA) for banks. • India adopted Basel-I norms in the year 1999. Under Basel-I, the RBI issued guidelines to maintain a CRAR (Capital to Risk Assets Ratio) or CAR (Capital Adequacy Ratio) of 9 per cent by every SCB. CRAR - It is defined as the proportion of bank's total risk-weighted assets that are held in the form of shareholders' equity and certain other defined class of capital.”
Why this source?
  • Gives a formal definition of CRAR/CAR as the proportion of a bank's capital (shareholders' equity and defined capital) relative to risk-weighted assets — i.e., CAR is held in the form of a bank's own funds.
  • Links the capital held to risk-bearing capacity by measuring it against risk-weighted assets, which implies its role in covering potential credit losses.
Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > 2 Money and Banking- Part I > p. 95
Presence: 4/5
“Scheduled Commercial Banks have achieved the minimum Basel III capital requirement. The higher the capital is above the regulatory minimum, the greater the freedom banks have to make loans. The closer bank capital is to the minimum, the less inclined banks are to lend. If capital falls below the regulatory minimum, banks cannot lend or face restrictions on lending. When loans go bad and turn into non-performing assets (NPAs) banks have to make provisions for potential losses (i.e., banks are required to keep certain funds in reserve which they can't lend and is called provisioning against NPAs). This tends to erode bank capital and put brakes on loan growth.”
Why this source?
  • Explains that when loans turn bad (NPAs) banks make provisions that erode bank capital, indicating that bank capital functions as a buffer against loan losses.
  • Notes that erosion of capital constrains lending, showing capital's practical role in absorbing losses from defaults.
Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > 2 Money and Banking- Part I > p. 94
Presence: 4/5
“3 crore and loan against some collateral/security of Rs 1 crore. RBI specifies the risk weights of various kinds of assets depending on their risk profile. Just assume that personal loan has risk weight of 100% and loan against collateral has risk weight of 50%. Now let us calculate the Capital to Risk Weighted Asset Ratio (CRAR) of each Bank. Since CRAR of Bank1 is higher, it implies that the depositor's money is safer in Bank1 as compared to Bank2. Hence, higher the capital to risk weighted asset ratio (CRAR), higher is the safety of bank deposits. Even without calculating the CRAR ratio, we can compare the safety of depositor's money in Bank1 and Bank2.”
Why this source?
  • Illustrates CRAR computation using risk weights and ties a higher CRAR to greater depositor safety, reinforcing that capital cushions against risky/ non‑performing assets.
  • Shows the concept of risk-weighted assets used in CRAR, connecting the capital held to the risk of borrower defaults.
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