The Reserve Bank of India (RBI) on Friday stressed on the importance of dynamic or expected loan loss provisioning in order to maintain financial stability. “Dynamic or expected loan loss provisioning can contribute to financial stability by recognising the losses early in the cycle at the time of loan origination by building up buffers in good times that can be used in bad times, thereby limiting the consequences during a downturn,” said RBI executive director B Mahapatra.
According to Mahapatra, “While there is no guarantee that dynamic provisions will be enough to cope with all the credit losses of a downturn and therefore may not tame credit cycles by itself, the time has come for forward looking provisions which when properly calibrated can act as a dependable macro-prudential policy instrument, to hedge against risks in banks’ balance sheets thereby enhancing the resilience of both individual banks as well as banking system as a whole.”
Dynamic provisioning is a tool that certainly deserves attention from policy makers and regulators for it distributes the loan losses evenly over the credit cycle and so applies the breaks on an important source of pro-cyclicality in banking, Mahapatra said.
RBI in March had published a discussion paper on introduction of dynamic provisioning framework for comments from all the stakeholders.
According to the current regulations, the Indian banks make two types of provisions which include general provisions on standard assets and specific provisions on Non Performing Assets (NPAs). RBI has proposed to introduce dynamic provisioning for the banks to address procyclicality of capital and provisioning, RBI had then said “after the financial crisis, efforts at international level are being made to introduce countercyclical capital and provisioning buffers and it has accordingly prepared discussion paper on countercyclical provisioning framework with parameters calibrated based on credit history of Indian banks.”
Mahapatra added that: “In December 2009, a minimum Provisioning Coverage Ratio (PCR) was introduced by RBI to ensure build up of provisioning buffer when banks in general were making good profits. However, the same was intended to be an interim measure till the time any comprehensive scientific study based on credit history of our banks was attempted by RBI and till the time it comes with countercyclical provisioning framework.”