Saturday Brain Storming Thought (216) 30/03/2024
PROVISIONING COVERAGE RATIO (PCR)
A Provisioning Coverage Ratio (PCR) is the percentage of funds that a bank sets aside for losses due to bad debts
A high PCR can be beneficial to banks to buffer themselves against losses if the NPAs start increasing faster
PCR Formula
PCR = (Total provisions for NPAs) / (Total Gross NPAs) X 100
Importance of PCR
1) Banks set aside a portion of their profits as a provision against bad loans to deal in the times of default (prospective losses)
2) The PCR helps in estimating the financial health of bank
3) PCR of 70% is the benchmark as set by the RBI
4) A high PCR is good
5) Higher PCR means the bank is not vulnerable and the asset quality issue is taken care
6) The PCR helps in understanding the asset quality
7) Lower the asset quality, high will be the PCR
8) The Provisioning Buffer, that the banks create is useful when the banks NPA (Non Performing Assets) are on the rise
Key Takeaways of Coverage Ratio
1) Coverage Ratio, broadly, is a measure of the company’s ability to service its debt and meet financial obligations
2) Higher the coverage ratio, the easier it should be to make interest payments on its debt or pay dividends
3) Coverage Ratio comes in several forms and can be used to help identify companies in a potentially troubled financial situation
4) Common coverage ratios include the interest coverage ratio, debt service coverage ratio and asset coverage ratio
Asset classification and provisioning norms as per RBI guidelines
RBI categorizes loans and advances into various asset classifications based on their performance
1) Standard Assets
These are loans that are performing as per terms and conditions
Banks are required to maintain provision of 0.25% to 0.40% depending on type of loan
2) Substandard Assets
These are assets where there is a defined weakness or default in repayment
Banks are required to maintain a higher provision ranging from 15% to 25% based on the duration of default
3) Doubtful Assets
These assets have been classified as substandard for a specific period, and full recovery is doubtful
Provisioning for doubtful assets varies from 25% to 100% depending on duration of default
4) Loss Assets
These assets are considered irrecoverable
Banks are required to make a 100% provision for loss assets
Interest Coverage Ratio
The interest coverage ratio is calculated by dividing earnings before interest and taxes (EBIT) by the total amount of interest expense on all of the company’s outstanding debts
Cash Coverage Ratio for Banks
The Cash Coverage Ratio isa metric that measures a company’s capacity to pay down its liabilities with its existing cash
It is used to assess a company’s liquidity
Only cash and cash equivalents are included in the cash coverage ratio
Leverage Ratio and Coverage Ratio
Leverage ratio focuses on the balance sheet and measures the extent to which liabilities, instead of equity, are used to finance a company’s assets
Coverage ratios focus, instead, on the income statement and cash flows and measures a company’s ability to cover its debt-related payments
COMPILED BY:-
Er. Avinash Kulkarni
9822011051
Chartered Engineer, Govt Regd Valuer, IBBI Regd Valuer
