Banks told to limit floating provisions

The Reserve Bank of India (RBI) today said banks can use floating provisions only to offset losses which are exceptional and non-recurring in nature and do not arise from the normal course of business.

These are extraordinary circumstances and funds should be used to make specific provisions for loan accounts impaired due to such events.

Floating provisions are made by banks in excess of the provisions required to be made to meet regulatory provisioning for bad loans, standard loans as well as various risks including market risks.

In a circular to banks, the RBI said banks need to obtain approval of their boards and also prior permission of the central bank to use floating provisions for contingencies under extraordinary circumstances.

These extraordinary circumstances broadly fall under three heads "� general, market and credit. Under the general category, there can be situations where a bank is unexpectedly put to a loss due to events like civil unrest or collapse of currency in a country. The natural calamities and pandemics are also included in the general category.

The market category includes events such as a general melt down in the markets, which affects the entire financial system. And in the the credit category, only exceptional credit losses are considered as an extra-ordinary circumstance.

In 2005, banks were advised to voluntarily set aside provisions much above the minimum prescribed level as a desirable practice. Such additional provisioning adds to the overall financial strength of banks and also to the stability of the financial system.

The RBI had came across some cases where the floating provisions were used to smoothen profit growth. In a year where profits are likely to be lower or growth slowing, some banks were found to have utilised the floating provisions instead of making fresh provisions for bad loans or other regulatory provisionings.

As a consequence, the central bank had issued instructions on creation, use, accounting and disclosure of floating provisions.