RBI announces draft norms for transition to expected credit loss framework

The Reserve Bank of India (RBI) on Tuesday released draft norms on Expected Credit Loss (ECL)-based provisioning for commercial banks’ stressed loans and securities. This will replace the current incurred loss-based norms banks use to make provisions. The RBI intends to roll out a new provisioning regime from April 1, 2027. Banks will get four years, that is, till March 31, 2031, to make additional provision on the existing book.

 

“Determining ECL requires a bank to make an assessment, at each reporting date, if the credit risk on a financial instrument has increased significantly since initial recognition,” the draft norms said. If risk has increased then the bank is required to make a loss allowance, estimated based on lifetime expected credit losses. The RBI has said a bank shall use a general approach consisting of three key functions — Probability of Default (PD), Loss Given Default (LGD), and Exposure at Default (EAD).

 

The transitional adjustment amount, i.e., the difference between the ECL required as on April 1, 2027 (computed based on the balance sheet position as on March 31, 2027), and the provisions held as per the current norms as on March 31, 2027 be added back to the Common Equity Tier 1 (CET 1) capital, the RBI said.

 

The new regime has staging criteria for asset classification to make provisions. While provisions would be made based on the new regime, the RBI intends to retain the existing norms for classifying loans as non-performing assets (NPAs). There will be suitably calibrated prudential floors for broad exposure, separately under three stages for provisions. The proposed regime would use broad principles of model risk management for implementing ECL models.

 

In the ECL framework, banks need to adopt a three-stage approach to determine Significant Increase in Credit Risk (SICR).

 

A financial instrument is said to be under Stage 1 when it has not had a SICR since initial recognition, or has low credit risk, and for these instruments, 12-month ECL shall be recognised.

 

Stage 2 is when it has had a SICR since initial recognition but is not considered to be “credit impaired”. For such financial instruments, lifetime ECL shall be recognised.

 

A financial instrument is said to be under Stage 3 when it is considered to be “credit impaired” at the reporting date. For such instruments, lifetime ECL shall be recognised.

 

The RBI said banks will initially measure and recognise financial assets such as loans at fair value plus or minus transaction costs that are directly attributable to the acquisition or issue of the financial asset. Subsequently, such assets will be measured at amortised cost. There would be alignment of the income recognition norms based on Effective Interest Rate (EIR) method for ECL regime.

 

It has been proposed that the new directions are estimated to result in an additional one-time provisioning. However, the overall impact on the minimum regulatory capital requirements of banks is expected to be minimal as they continue to meet the capital requirements comfortably.

 

The regime is expected to further strengthen credit risk management practices, and promote greater comparability across financial institutions. It would also align regulatory norms with internationally accepted regulatory and accounting standards, the RBI added.

 

In its assessment, rating agency CareEdge said the estimated impact on capital adequacy would be up to 30 basis points (bps) based on 2024-25 (FY25) numbers. Banks already hold a buffer in the range of 2-8 per cent of Common Equity Tier I (CET1) capital.