Detailed Explanation:

Answer: Option 1 — 1 only

Capital Adequacy Ratio (CAR) is a regulatory measure that ensures banks maintain sufficient capital reserves to absorb potential losses from loan defaults and other financial risks, thereby protecting depositors' interests. Statement 1 correctly defines CAR as the capital banks must hold to offset losses if borrowers fail to repay dues, while Statement 2 is incorrect because CAR is mandated and regulated by the central bank (RBI in India), not decided by individual banks.

✅ Statement 1 – Correct: CAR represents the minimum capital that banks must maintain as a cushion against potential losses from loan defaults and other risks, protecting depositors and ensuring financial stability.

❌ Statement 2 – Incorrect: CAR is not decided by individual banks but is mandated and regulated by the Reserve Bank of India (RBI), which sets minimum CAR requirements to ensure uniformity and financial system stability.

📝 Short Notes: Capital Adequacy Ratio (CAR)

• Definition: CAR is the ratio of a bank's capital to its risk-weighted assets, expressed as a percentage.
• Regulatory Authority: In India, the Reserve Bank of India (RBI) sets and monitors CAR requirements for all banks.
• Purpose: Ensures banks have adequate capital buffers to absorb losses, protecting depositors and maintaining financial system stability.
• Minimum CAR in India: RBI mandates a minimum CAR of 9% for scheduled commercial banks (higher than Basel III's 8% requirement).
• Components: CAR includes Tier I capital (core capital like equity and disclosed reserves) and Tier II capital (supplementary capital like subordinated debt).
• Basel Norms: CAR requirements in India are aligned with Basel III international banking regulations.
• Impact: Higher CAR indicates a bank's greater capacity to withstand financial stress and protects against insolvency.