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RBI now uses divergence to compel banks to improve their loan-loss ratios
- At least three public sector banks (Union Bank of India, Indian Bank and Central Bank of India) that have reported earnings for the January-March quarter have mentioned ‘divergence’ in bad loan recognition and have made provisions for such loans.
- These three state-run banks, had reported divergence for the financial year 2017-18, while announcing the results.
- Divergence takes place when the Reserve Bank of India (RBI) finds that a lender has under-reported (or not reported at all) bad loans in a particular year and hence asks the lender to make disclosures if under-reporting is more than 10% of bad loans or the provisioning.
- Interestingly, divergence was identified not because these banks hadn’t classified the loan as non-performing assets (NPA) but because they were late in classifying them.
- Since the date of classification as NPA, the banks had to make higher provisioning due to the ageing factor.
- In the first stage of NPA, which is the ‘sub-standard’ category, 15-20% provision is required and for next category, which is ‘doubtful’, a 40% provision is required.
- Some bankers said the identification was pushed back by two years in some cases. Since banks had to increase their provisioning, this resulted in higher provision coverage ratios (PCR).
- Divergence refers to the price of an asset moving in the opposite direction from the measurement indicator It is not present for all major price reversals, it is only present on some.
- The price or the performance actually moves contrary to the prediction made on the performance of that particular asset. The price trend seems weakening with divergence.
- Divergence is observed as positive and negative.
- Positive Divergence: If the price goes up than expected it is a positive divergence. Positive divergence signals price could start moving higher soon. It occurs when the price is moving lower but a technical indicator is moving higher or showing bullish signals.
- Negative Divergence: If the price goes down than expected it is negative divergence. Negative divergence points to lower prices in the future. It occurs when the price is moving higher but a technical indicator is moving lower or showing bearish signals.
- Divergence is typically used by technical traders when the price is moving in the opposite direction of a technical indicator.
Provisioning Coverage Ratio (PCR):
- The Provisioning Coverage Ratio is the percentage of bad assets that the bank has to provide for (keep money) from their own funds most probably profit.
- For example, if the Provisioning Coverage Ratio is 70% for a particular category of bad loans, banks have to set aside funds equivalent to 70% those bad assets out of their profits (in most cases).