UPSC Prelims 2018 Q16: Indian Economy – Banking & Financial Sector
- (a) 1 only
- (b) 2 only
- (c) Both 1 and 2
- (d) Neither 1 nor 2
Answer: (a) 1 only
Explanation
Capital Adequacy Ratio (CAR / CRAR)
| Statement | Claim | Verdict | Detail |
|---|---|---|---|
| 1 | CAR is the amount banks maintain in own funds to offset losses if borrowers default | TRUE | CAR (also called CRAR - Capital to Risk-weighted Assets Ratio) = (Tier 1 + Tier 2 capital) / Risk-weighted assets. It acts as a cushion against credit, market and operational risk. |
| 2 | CAR is decided by each individual bank | FALSE | CAR is prescribed by the RBI in line with Basel III norms. Currently RBI requires 9% minimum CAR (Basel III floor is 8%) + Capital Conservation Buffer of 2.5% = effectively 11.5%. Banks cannot set their own CAR. |
Answer: (a) 1 only.
Why each option is right or wrong
- (a) CORRECT. Only Statement 1 is right - CAR is the capital cushion against borrower defaults.
- (b) Incorrect. Statement 2 is factually wrong - CAR is set by the RBI, not by individual banks.
- (c) Incorrect. Individual banks cannot decide their own capital adequacy - this is a prudential regulation.
- (d) Incorrect. Statement 1 correctly describes the function of CAR.
Key point
CAR (CRAR) = (Tier 1 + Tier 2 capital) / RWA. Minimum in India: 9% (RBI) + 2.5% CCB = 11.5%. Follows Basel III. Set by RBI, not banks. Also called capital adequacy or capital-to-risk-assets ratio.
Remember
Capital Adequacy Ratio (CRAR) is a bank's capital as a percentage of its risk-weighted assets. It cushions the bank against losses from loan defaults and other risks. The ratio is prescribed by the RBI in line with global Basel III norms - currently 9% plus a Capital Conservation Buffer of 2.5% - and is not decided by individual banks.
Common mistakes
- Confusing CAR with CRR (Cash Reserve Ratio) or SLR (Statutory Liquidity Ratio) - CAR is about equity/loss absorption, CRR/SLR are about liquidity/reserves.
- Thinking CAR is optional - it is a mandatory prudential norm from the RBI under Basel III.
- Missing Basel III components - Common Equity Tier 1 (5.5%), Tier 1 (7%), and CAR (9%) with additional buffers.
Exam tip
Basel III memory hook: CET1 = 5.5%, Tier 1 = 7%, CAR = 9% (RBI floor), + CCB 2.5% = 11.5% effective. G-SIBs get additional surcharge. India's Basel III implementation follows RBI guidelines.
Sources
- RBI Master Circular on Basel III Capital Regulations
- NCERT Class 12 - Macroeconomics (Money and Banking)