The Reserve Bank of India (RBI) on Monday allowed banks to divert a greater share of a mandatory contingency fund to provide for bad loans, a move that will improve lenders’ profitability and bolster their balance sheets.

RBI’s announcement sent banking stocks up 1-3%.

Under the new rules, banks can use half or 50% of their so-called “counter-cyclical buffer” — a mandatory safety fund that banks have to set aside to deal with extraordinary economic shocks — to provide for non-performing assets (NPAs), up from 33% allowed earlier.

NPAs are loans that do not yield returns.

“It has now been decided, as a counter-cyclical measure, to allow banks to utilise up to 50% of counter-cyclical buffer/floating provisions held by them as at the end of December 31, 2014, for making specific provisions for non-performing assets (NPAs), as per the policy approved by their board of directors,” the central bank said in a notification.

The move to allow banks to dig deeper into its pool of “counter-cyclical buffer” will reduce their dependence on ordinary capital to provide for stressed assets or loans that have a greater chance of turning bad.

In the last few years, NPAs of banks, particularly those in the public sector, have been rising due to stalled projects, sluggish domestic growth and slowdown in many parts of the global economy.

NPAs of banks topped Rs 3 lakh crore as on December 2014, of which Rs 2.62 lakh crore belonged to the nationalised banks alone, minister of state for finance Jayant Sinha said in the Lok Sabha recently.

Gross NPAs have soared from Rs 69,000 crore in 2009 to more than Rs 3 lakh crore currently.

The relaxation provided by RBI on Monday will reduce the hit on banks’ profits caused due to rising cases of NPAs, analysts said.

PTI reported that RBI also proposed that non-banking financial companies (NBFCs) would have to take prior approval from the regulator for takeover or acquisition of such firms that would  result in change in ownership or control. The final norms would be decided after taking into account views of various stakeholders.(PTI - HT)