ECL norms to have bigger impact on banks with higher unsecured loans

Expected credit loss framework to replace incurred loss model from April 2027; analysts say lenders with higher unsecured retail and microfinance exposure will see bigger provisioning impact

Commercial banks with higher proportion of unsecured loans — like personal loans, credit card and microfinance exposure — are likely to have a higher impact of the Reserve Bank of India’s (RBI’s) expected credit loss (ECL) norms, according to analysts.

 

During the monetary policy review meeting, RBI Governor Sanjay Malhotra announced that the transition to ECL framework from the current incurred loss framework will start from April 1, 2027.

 

RBI is yet to announce draft ECL norms. A discussion paper was floated in early 2023.

 

According to analysts at Nuvama, ECL will impact microfinance institution (MFI) banks like AU Small Finance Bank (SFB), RBL Bank, IDFC First Bank and IndusInd Bank.

 

They added, “It will also impact state banks on existing loans. Three years ago, State Bank of India (SBI) had disclosed a shortfall of ~25,000 crore for existing loans, which in our view would have reduced to below ~20,000 crore.”

 

The RBI further added that the institutions will be given a glide path till FY31 to smoothen the impact of one-time provisioning on their existing books.

 

Under the ECL norms, banks will be required to classify financial assets (primarily loans, including irrevocable loan commitments, and investments classified as held-to-maturity or available-for-sale) into three categories. They are Stage 1, Stage 2, and Stage 3, depending upon the assessed credit losses on them at the time of initial recognition as well as on each subsequent reporting date and make necessary provisions.

 

“Large banks have seen an improvement in asset quality trends in the last few years and also have a higher provision buffer to better navigate this transition.

 

Mid-sized banks — especially the ones having higher share of personal loans, credit cards and microfinance, and have seen higher asset quality deterioration in recent times, like IndusInd Bank, Bandhan Bank, RBL Bank and IDFC First Bank, among others — would be adversely impacted. They might have to set aside higher provisioning, and it may impact their profitability,” analysts at JM Financial said.

 

The impact of ECL will vary for banks based on their product mix, quality of portfolio, and current provisioning levels.

 

“From a product perspective, incremental provisioning under ECL is likely to be higher for microfinance loans and unsecured retail loans such as personal loans, credit cards, and certain digital lending or co-lending products,” said Jatin Kalra, partner, Grant Thornton Bharat.

 

For corporate lending, the impact is expected to vary based on exposure to stressed sectors and underwriting practices. ECL will also cover committed exposures, such as non-funded facilities, that pose credit risk.

 

“The impact is expected to be moderate for small and medium enterprise (SME) business loans and loans against property (LAP) and vehicle finance; and lower for housing and gold loans. Interestingly, the RBI has proposed regulatory backstops and floors to limit model divergence and ensure consistency across banks,” Kalra added.

 

Although large private banks should have minimal impact on one-time transition, analysts expect some public sector banks and mid-sized banks with lower contingency provision buffers to see some negative impact because of the new norms.

 

However, they believe that phased implementation of ECL norms should limit the impact and transition should be smooth.