July 30, 2026
What is Provision Coverage Ratio (PCR)? Bad Loan Cushion Explained
The Answer
The Provision Coverage Ratio (PCR) measures the percentage of bad loans (GNPAs) for which a bank has set aside capital (provisions) to absorb defaults. A PCR Drop indicates the bank is reducing its safety buffer relative to outstanding bad loans, leaving it vulnerable to sudden capital write-downs.
Why it Matters
When provisions drop, short-term earnings look artificially higher because less money is set aside from the income statement. However, it leaves the bank's capital base fully exposed if bad loans default, which can trigger structural insolvency.
Sentinel Insight
āBanks often lower PCR to dress up quarterly earnings. Avoid lenders who reduce provision buffers while Gross NPAs are rising.ā
š How to Interpret
In Risk Context
Flagium tracks PCR Drop as flag F8 (Weight: 10). It fires when the PCR ratio falls below peer sector medians or regulatory safety benchmarks (typically < 70%).
Deep Dive
Provision Coverage Ratio: The Solvency Cushion
When a bank classifies a loan as an NPA, accounting regulations require it to write off a portion of that loan by setting aside cash from its income statement. These cash reserves are called Provisions.
The PCR Formula
The Provision Coverage Ratio (PCR) measures the safety cushion built against outstanding bad loans:
A high PCR (e.g. 75%) means that even if 75% of the bank's bad loans turn out to be completely unrecoverable, the bank has already absorbed the loss. Conversely, a PCR Drop means the bank's cushion is shrinking.
How Flagium Detects Provision Coverage Drop
Flagium tracks provisions relative to Gross NPAs. If the Provision Coverage Ratio drops below or falls sequentially while GNPA is rising, it triggers the F8 flag.
The Earnings Dressing Trap
Setting aside provisions directly reduces a bank's Net Profit. During quarters when a bank experiences credit stress (rising NPAs), management can make a tactical decision to lower provisions to keep reported Net Profit (PAT) flat.
For example:
- Quarter 1: GNPA = ā¹100 Cr, Provisions = ā¹70 Cr (PCR = 70%).
- Quarter 2: GNPA rises to ā¹130 Cr. If the bank maintains a 70% PCR, it must set aside an extra ā¹21 Cr in provisions, reducing profits.
- Dressed Scenario: The bank keeps provisions at ā¹70 Cr (PCR drops to 53.8%). Reported profits look strong, but the bank's safety cushion is severely compromised.
Spotting Under-Provisioning
Watch out for these warning signs:
- Divergence in Growth Rates: Gross NPAs growing at 20% QoQ while Provisions grow at only 5%.
- PCR dropping below 65%: In Indian banking, a PCR below 60% is a critical solvency warning, leaving the lender vulnerable to sudden capital erosion.
- Write-offs accelerating: The bank is writing off bad loans directly from the equity base rather than through provisions.
Detect risk early
Flagium tracks these signals across multiple quarters to help you avoid structurally weak companies before it reflects in price.
Check provision coverage ratios āš