Draft ECL framework: Banks plan to move RBI for lower Stage-II floor

Commercial banks are planning to request the Reserve Bank of India (RBI) to lower the provisioning requirement for Stage-II loans as proposed in the draft Expected Credit Loss (ECL) framework for loan-loss provisioning released last month.

 

For Stage-II loans, most of which fall under the Special Mention Accounts 1 or 2, (SMA1/SMA2) in the current incurred-loss regime, the RBI has set a floor, or minimum requirement, of 5 per cent (of loan exposure) provision in the ECL regime. Banks generally make 0.4 per cent provisions for such loans now.

 

According to a senior banker from a large public-sector bank, the provisioning burden would increase significantly if the proposed 5 per cent floor is implemented. The banker, who did not wish to be named, said various geographies in the world, including advanced economies, do not prescribe any floor for Stage-II loans, and even if they do, such a high floor is not mandated.

 

Moreover, banks will also request that loans that are lowered to Stage-III should be immediately classified to Stage-I once dues are cleared, so that the extra provision is reversed. The RBI has proposed a six-month curing period in Stage-II after regularisation before a loan is brought under Stage-I. 

 

Banks are planning to make a representation to the regulator shortly. The deadline for submitting feedback on the draft ECL framework is November 30.

 

To determine a significant increase in credit risk (SICR), the draft has proposed three stages. A financial instrument is said to be under Stage-I when it has not had a SICR since initial recognition or has low credit risk. It comes under Stage-II when it has had an SICR since initial recognition but is not yet considered “credit-impaired”. Stage-III is when the financial instrument is deemed “credit-impaired” as of the reporting date.

 

“For Stage-II loans, the provisioning floor is higher at 5 per cent for most portfolios. That’s a very significant increase from 0.4 per cent, which is currently the requirement for SMA1 and SMA2 category loans. So, for Stage-II loans in particular, ECL will result in much higher provisions, but it is justified because these are loans with increased credit risk,” said Jatin Kalra, partner, Grant Thornton Bharat.

 

While Stage-I provision burden may not reduce, the Stage-II requirement will increase. Overall, there will be a net increase in provisioning requirements for most banks.

 

“The floors introduced, while helping maintain conservatism, may result in divergence from globally followed ECL, as other countries generally don’t have floors to this extent. Most countries like the US, UK, Australia, and the UAE have very limited or no minimum floors,” Kalra said, adding that in ECL banks must track credit risk proactively, and when they see increased stress, they have to create increased provision. The transition to the ECL framework for loan-loss provisioning will ensure adequate capital buffers and enhanced resilience for banks.

 

The draft norms have proposed a transition to the ECL framework from April 1, 2027. Banks will get four years to spread the additional provisioning requirement on their existing loan books.

 

“The RBI’s move to introduce a 5 per cent ECL floor on Stage-II assets could lift provisioning levels from around 0.45 per cent to nearly 1.50 per cent, with the ultimate impact depending on each bank’s portfolio mix, asset quality, and historical performance,” said Dhruv Parikh, partner (financial services risk consulting), EY India.

 

“This shift will compel institutions to rethink their credit, risk, and capital strategies. Over time, banks that invest in stronger underwriting, monitoring, and collection frameworks will emerge more resilient and sustain greater market confidence,” Parikh added.