What is a statutory reserve?

A statutory reserve is any reserve that has to be maintained by an Act or law. When it comes to insurance, a statutory reserve is a reserve that an insurance company is legally bound to maintain to ensure that the company is able to meet its policy obligations. In India, as per the Banking Regulations Act, every banking company has to maintain at least 25% of its net profits as statutory reserves.

The companies are required to maintain such reserves to guarantee the availability of cash when it is required by the customer. Common examples of statutory reserves are Cash reserve ratio (CSR), Statutory Liquidity Ratio (SLR).

Treatment

• Statutory reserves are shown in the Profit and Loss account under the head “appropriations”.
• It is also shown under the head Reserves and Surplus (Schedule 2) in the Balance Sheet.

Method

Rule-Based Approach – The company calculates the amount required by using standard formulas. However, since they are pre-determined formulas, it does not cover all risk determining factors.

Principle-based approach – This method is used to protect customers and ensure that the company stays solvent. They hold a higher amount of reserves than required after predicting all possible risks.

Statutory reserves are different from general reserves as general reserves are maintained voluntarily by the company. A company that does not follow statutory requirements will face financial penalties. These reserves are mostly maintained in the form of cash.

Maintenance of reserves gives confidence to investors that their money is secure. However, funds from these reserves can be used only for specific purposes. They should also maintain such reserves whether or not they earn profits.