Banks can no longer use floating provisions

The Reserve Bank of India (RBI) has clamped down on utilisation of floating provisions by banks to boost profits.

In a circular to all banks, RBI banned reversal of floating provisions by credit to the profit and loss account. The floating provisions can only be utilised for making specific provisions in extraordinary circumstances.

The floating provisions can be used only for contingencies under extraordinary circumstances for making specific provisions in impaired accounts after obtaining board's approval and with prior permission of the RBI. The boards of the banks have been asked to lay down an approved policy as to what circumstances would be considered extraordinary.

Until such utilisation, banks have been allowed to use the floating provisions for netting off from gross non-performing assets (NPAs) to arrive at disclosure of net NPAs. Alternatively, the provisions can be treated as
part of Tier II capital within the overall ceiling of 1.25% of total risk-weighted assets.

RBI said the use of floating provisions to set-off against provisions required to be made appear to have been used in "smoothening of profits in some cases" and hence it decided to revise the instructions on utilisation,
creation, accounting and disclosures of floating provisions.

Banks' boards have been directed to lay down approved policy regarding the level to which the floating provisions can be created. Banks should hold floating provisions for 'advances' and 'investments' separately and the
guidelines prescribed will be applicable to floating provisions held for both 'advances' & 'investment' portfolios, RBI said.

Setting apart provisions much above the minimum prescribed level as a desirable practice due to the fact that higher loan loss provisioning adds to the overall financial strength of banks and the stability of the financial sector.

Banks have also been allowed to voluntarily make specific provisions for advances at rates which are higher than the rates prescribed provided such higher rates are approved by banks' boards and consistently adopted from
year to year. Such additional provisions are not to be considered as floating provisions, RBI pointed out.