Provisioning is about making arrangements to cover to provide cushion for the bad days. Banks need to cushion their loans which may have turned into Non Performing Assets.
Provisioning Coverage Ratio (PCR) is essentially the ratio of provisioning amount to gross non- performing assets and indicates the extent of funds a bank has kept aside to cover loan losses.
In other words, PCR is the percentage of bad assets that the bank must provide from their own funds.
Provisioning should be made on the basis of the classification of assets based on the period for which the asset has remained non performing and availability of security and the realizable value thereof.
Provisioning coverage ratio differs in terms of quality of assets. Some assets may be lost forever and they are categorised as loss assets. This implies that such loans will never be repaid. For such assets bank must set aside 100% of such loss assets.
Similarly, there may be sub-standard assets where the loans are not repaid for a shorter period. In this case, less proportion of those assets can be set aside from profit.
It is mandatory for the Indian banks to create a provision fund to cover their anticipating bank loans. It is also mandatory for the banks to disclose the PCR and their annual financial statements in notes to accounts to the balance sheet.
Importance of PCR: Banks set aside a portion of their profits as a provision against bad loans to deal in times of default (Prospective losses).
The PCR helps in estimated the financial health of bank. A high PCR is good. Higher PCR means bank is not vulnerable and asset quality issue is taken care. Typically, a PCR ratio of 70%+ is considered healthy for banks as set by RBI.
PCR helps in understanding the asset quality. Lower the asset quality, high will be the PCR.
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