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:
Answer & explanation
Answer: (a) 1 and 2 only
The Interest Coverage Ratio (ICR) is a firm's earnings before interest and tax divided by its interest expenses, so a higher ICR means the firm can pay its interest more easily. That makes statement 3 wrong. Banks use ICR to gauge a borrower's current repayment strength and, by tracking it over time, its emerging risk.
- ✓ 1. ICR shows how many times current earnings cover interest due. RBI treats an ICR below unity (below 1) as an indicator of a firm's financial vulnerability, so it shows the borrower's present risk.
- ✓ 2. ICR is worked out period after period. A falling trend warns that repayment strength is eroding before default happens, so it also helps a bank see emerging risk.
- ✗ 3. It is the reverse: a higher ICR means better ability to service debt. RBI describes an improving ICR as a sign of improved debt servicing.
Remember · ICR = EBIT ÷ interest expenses. Higher is safer; below 1 means earnings do not even cover interest.
Sources
- RBI, Financial Stability Report, June 2025 (footnote on interest coverage ratio) ↗ “The interest coverage ratio is the ratio of earnings before interest and taxes (EBIT) to interest expenses.”
- RBI, Financial Stability Report, December 2023 ↗ “Despite increase in interest burden, the debt share of NFCs with ICR below unity, an indicator of a firm’s financial vulnerability, is on a decline, helped by improving profitability.”
- RBI, Financial Stability Report, January 2021 (Issue No. 22) ↗ “the manufacturing sector posted improvements in operating profits and in debt servicing, the latter being reflected in the improvement in their interest coverage ratio (ICR).”
Question and answer: UPSC's official GS Paper I (2020, Series A) — paper ↗ · answer key ↗. Explanation: Minimalist IAS, checked 30 Sept 2026 (how we verify). ·