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:

The correct answer is A) 1 and 2 only. Interest Coverage Ratio (ICR) is usually computed as EBIT divided by interest expense. It tells a lender how many times a firm's operating earnings can pay its interest bill in a given period.

Statement 1 is correct. A single-period ICR shows whether the borrower's current earnings comfortably cover its present interest obligations. That is the present risk a bank must price before sanctioning a loan.

Statement 2 is correct. Tracking ICR across several quarters or years reveals a falling trend before the firm actually defaults. That is the emerging risk, and it is why banks look at the trajectory, not just one ratio.

Statement 3 is wrong. The relationship is inverted. A higher ICR means a bigger cushion of earnings over interest, so the firm is better placed to service its debt. An ICR below 1 means earnings do not cover interest at all.

The concept links to the stressed-asset problem in Indian banking, the rise in NPAs in the 2010s and the IBC, 2016 framework. For Mains, it is a good example of how lending decisions depend on financial ratios.

Trap: Aspirants sometimes assume that 'coverage' ratios work like leverage ratios, where a higher number means more debt risk. Here, a higher number is safer.