What is the importance of the term "Interest Coverage Ratio" of a firm in India ? 1. It helps in understanding the present risk of a firm that a bank is going to give loan to. 2. It helps in evaluating the emerging risk of a firm that a bank is going to give loan to. 3. The higher a borrowing firm's level of Interest Coverage Ratio, the worse is its ability to service its debt. Select the correct answer using the code given below :
- (a) 1 and 2 only ✓ UPSC's answer
- (b) 2 only
- (c) 1 and 3 only
- (d) 1, 2 and 3
Why the answer is (a)
• Interest Coverage Ratio (ICR) = earnings before interest and tax ÷ interest expense; it shows how comfortably a firm can pay interest from operating profit.
• Statement 1 is correct: a lender uses the current ICR to gauge the firm's present ability to service debt.
• Statement 2 is correct: tracking ICR over time reveals emerging stress — the RBI's Financial Stability Report flags firms with ICR below 1 as vulnerable.
• Statement 3 is wrong: a higher ICR means a better, not worse, ability to service debt.
• Hence 1 and 2 only, option (a).
Why the other options are wrong
- (b) 2 only
- Statement 1 is also correct: ICR shows present risk.
- (c) 1 and 3 only
- Statement 3 is wrong: higher ICR means better debt-servicing ability.
- (d) 1, 2 and 3
- Statement 3 is wrong.
Asked in the GS Paper I of the UPSC Civil Services Preliminary Examination 2020, held on 4 October 2020. Question and answer key: Union Public Service Commission. Explanation: UPSC Answer Check.