Loan provisioning in banks: RBI for expected loss-based approach

Bankers say with low NPAs and high provisions, the time is ripe for global standards

With robust asset quality, high capital adequacy, and provisions cover, bankers on Friday said the time was appropriate for the Reserve Bank of India (RBI) to prepare lenders to adopt the “expected credit loss” (ECL) regime in making provisions for loans.

The ECL approach and framework for securitising stressed assets will make the system robust.

But the implications -- the extent of the burden and need to use the capital pool for any enhanced provisions -- will become clear only when the RBI spells out the details in a discussion paper, they said.

Banks now make provisions on the incurred loss model, which is after defaults occur.

RBI Governor Shaktikanta Das in his speech on Friday said a more prudent and forward-looking approach was the expected loss-based approach.

This requires banks to make provisions based on an assessment of probable losses. The RBI will shortly come up with a discussion paper on the transition.

The RBI said the current incurred-loss approach was inadequate and this was amplified during the global financial crisis (GFC). Some large non-banking financial companies (NBFCs) in India follow the ECL approach for estimating credit losses.

Pointing to the relevance of the ECL approach, Dinesh Khara, chairman, State Bank of India, said at present gross non-performing assets (NPAs) and net NPAs were low -- below 6 per cent and 2 per cent -- respectively.

The provision cover ratio (PCR) and capital adequacy levels are high. This is the right time to start preparing for moving to the ECL approach. It will be a stepping stone to adopting the International Financial Reporting Standards and will make the Indian banking system robust.

A K Goel, chairman, Indian Banks’ Association (IBA), and managing director (MD) and chief executive officer (CEO), Punjab National Bank, said the IBA had represented to the RBI on the need for adopting the expected loss method-based (ELM-based) credit rating for infrastructure projects. It is heartening to note that the RBI is taking cognisance of the representation, he said.

Besides lower NPAs and enhanced provisions, banks have raised substantial capital and tightened credit appraisal and monitoring. There has been a lot of cleaning up in the banking system for four to five years.

Anil Gupta, co group head, financial sector ratings, ICRA, said with an improved capital position along with high provision cover on NPAs, the banks were likely to be well positioned to take an incremental hit, if any, on capital.

At the system level, a rise in provisioning is unlikely to be significant. The corporate stress cycle has mostly played out and banks have been making materially higher provisions than what norms prescribe.

Additionally, the incremental slippages in the system are likely to trend lower, said Prakash Agarwal, director and head, financial institutions, India Ratings and Research.

The RBI also said it would introduce a framework for securitising stressed assets in addition to the asset reconstruction company route, similar to the framework for securitising standard assets.

Zarin Daruwala, cluster CEO, India and South Asia markets (Bangladesh, Nepal and Sri Lanka), Standard Chartered Bank, said the proposed enhancements to the securitisation framework and convergence with global loan loss provisioning standards would help secure the banking system.

Developing an additional framework for securitising stressed assets is a forward-looking approach to managing NPAs in the country, said RK Bansal, MD and CEO, Edelweiss ARC.