Mumbai: The Reserve Bank of India (RBI) on Friday tweaked its norms on how much money banks should set aside to cover bad debt and said excess provisions made after September 2010 be used to cushion shocks “during periods of system-wide downturn”.
Under the existing rule, banks are required to set aside 70% of their bad debt as provision, known as the provision coverage ratio (PCR).
Many banks, especially the nation’s largest lender State Bank of India (SBI), have complained that the requirement is high and dents their profitability. But RBI has been insisting that this is a part of prudential norms in sync with international banking practice.
Given a choice, banks are not keen on setting aside such large amounts on an ongoing basis.
RBI on Thursday said till such time it introduces a more comprehensive methodology of “counter-cyclical provisioning taking into account international standards”, PCR of 70% should be in reference to the gross non-performing assets (NPAs) position in banks as on 30 September.
This means, beyond this cut-off period, banks will not be required to set aside money for 70% coverage even if NPAs grow. And if their NPAs come down, the surplus of the provision under 70% PCR will be kept in an account called the “counter-cyclical provisioning buffer”.
This will be used by banks for making specific provisions if they pile up bad assets during any systemic downturn, with the approval of the banking regulator.
There are three types of NPAs, or bad debt—sub-standard, doubtful and loss assets.
Sub-standard refers to any loan that has not been serviced for 91 days, which requires a provision of 10%. Doubtful assets, depending on their age, carry a provision of 20-100%, while banks are required to make 100% provision for loss assets.
RBI had replaced this with a blanket coverage of 70% PCR irrespective of the classification. But from now on, banks will follow the old norm, and any excess provision that has already been made as of September will be transferred to the “buffer account”.
The biggest beneficiary of this new norm will be SBI. It has till December made 64% provisioning and was committed to meet the 70% norm by September.
But it won’t need to make the extra provision as, according to an analyst with a local brokerage, it has covered 72% of its bad assets as of 30 September. Had it been required to make provisions on an ongoing basis, it would have needed to set aside at least Rs2,000 crore more. To that extent, profits would have been depressed.
“SBI’s headache is over,” said the analyst, who did not want to be named because of his company’s media policy.
Most banks have a PCR in excess of 70% and are unlikely to benefit from the rule change as the excess will go to the buffer account.
RBI said any bank that has been granted an extension of time beyond the stipulated date of 30 September for achieving PCR of 70% “should calculate the required provisions for 70% PCR as on 30 September 2010” and cover any shortfall. “This shortfall should be built up at the earliest, and these banks should reassess the further time required beyond 31 March 2011, if any, to build up the buffer and seek approval from RBI.”
This is not the first time the central bank is initiating such measures to protect banks. In January 2002, when interest rates were low, RBI prodded banks to build up an investment fluctuation reserve (IFR). By October 2003, yield on the 10-year bond dropped to a historic low of 4.97%. But when rates began reversing in late 2004, IFR helped banks absorb the impact of rising interest rates and mark-to-market (MTM) losses in their bond portfolios. MTM is an accounting practice of valuing assets in accordance with their market value and not the price at which they are bought.
Bond yields and prices move in opposite directions. When yields rise and prices drop, banks suffer MTM losses. IFR helped them cushion this loss.