The Reserve Bank of India, or RBI, wants commercial banks to set aside funds to cover at least 70% of their non-performing assets, or NPAs, by September 2010. Technically, this is called the provision coverage ratio. Currently, the provisioning requirements for NPAs range between 10% and 100%, depending on the age of the stressed assets and the security or collateral available against them.

Banks have been distinctly unhappy with the move because they would need to set aside a huge amount of money to achieve the 70% coverage and this would hurt their profitability.

They lobbied hard and forced the central bank to soften the blow on their profitability when RBI issued a formal notification in early December. They are allowed to take into consideration written-off accounts while computing the coverage. This has made the move virtually meaningless.

Before we get into the nitty-gritty of the issue, let’s take a close look at the quality of assets at Indian banks. Three critical factors to assess banks’ health are the capital adequacy ratio (CAR), or the ratio of capital to risk-weighted assets, NPAs as a percentage of total assets, and the provision ratio. According to the April 2009 Global Financial Stability Report of the International Monetary Fund, Indian banks’ net NPAs were 2.3% of total assets in fiscal 2008.

Indian banks’ CAR in 2008 was 13%. This means they had Rs13 worth of capital for every Rs100 in assets. Chinese banks’ CAR was much lower (8.2%) and that of Japan and the US marginally lower (12.3% and 12.5%, respectively), but Brazil and Russia had a much higher CAR. Indian banks’ provision cover in 2008 was only 52.6%, against 171% of Brazil, 140% of Russia and 115% of China. US banks’ provision coverage was about 85%. Only the Japanese banks had a lower provision cover, at 25%.

What is a written-off account? Write-offs are considered as a last resort by banks when all means of recovering a bad loan are exhausted. Unlike provisioning, where the loan assets and the provisions remain on the books of the banks, written-off accounts go off the balance sheets. Such accounts are, however, maintained by the banks as accounts under collection at the branch level. Since they do not form part of the annual reports of the banks, there is no transparency in their disclosure to stakeholders of banks.

Now, take a look at the current provision coverage ratio of some of the large banks. Punjab National Bank has the highest coverage ratio—around 91%. Among others, Union Bank of India has a coverage ratio of 88%, Bank of Baroda 79%, Central Bank of India 74% and HDFC Bank Ltd 70%. Five large banks have less than 70% coverage ratio. For instance, State Bank of India, the country’s largest lender, has a coverage ratio of 43% and ICICI Bank Ltd, the largest private bank, 51%. Bank of India’s coverage ratio is 59%, Canara Bank’s 28% and Indian Overseas Bank’s 54%.

State Bank of India alone would have needed to set aside at least Rs4,700 crore to achieve the stipulated 70% coverage by September 2010. This is little less than 50% of the bank’s net profit in 2009. ICICI Bank would have needed a little more than Rs1,700 crore, about 45% of its net profit. For Canara Bank, it would have been Rs990 crore, about 90% of its 2009 net profit. Collectively, these five banks would have required to set aside Rs8,290 crore to achieve the 70% coverage target. Their combined net profit in 2009 was a little more than Rs10,800 crore.

But they would not have to provide so much as the written-off accounts would come to their rescue. If we consider their written-off accounts for the purpose of computing the provisioning coverage ratio, then my estimate (mind you, this is only an estimate as I do not have the precise figures) is that Bank of India’s coverage ratio would jump from 59% to 73%. This means, it would not need to set aside even one rupee. Canara Bank’s coverage ratio would rise from 28% to 57% and that of State Bank from 43% to 62%. ICICI Bank’s coverage will go up from 51% to 55%. Overall, these five banks’ provisioning requirement will come down substantially—from Rs8,290 crore to Rs4,450 crore.

Should banks be allowed to do so? A write-off is a carefully considered decision by a bank’s board and being not recoverable such accounts do not have any value. They do not even find a place on a bank’s balance sheet. Why would one recognize these assets again just to help a bank window dress its books? It makes a mockery of accounting practices.

If the written-off accounts have any value, then banks need to justify the write-off in the first place to the income tax authorities, as they get a tax benefit on such accounts. The amount of written-off accounts are subtracted from bank profits while computing their tax liability and to that extent they pay less tax. No one disputes the resilience and strength of the Indian banking system. There is no need to create an optical illusion of a higher provision coverage.

Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as Mint’s deputy managing editor in Mumbai. Please email your comments to