Expected Credit Loss (ECL)-Based Provisioning for Banks
The Reserve Bank of India (RBI) announced draft norms for ECL-based provisioning, set to replace the current incurred loss-based norms for stressed loans and securities in commercial banks by April 1, 2027. The transition aims to enhance credit risk management and align with international standards.
Key Features of ECL-Based Provisioning
- Implementation Timeline:
- Banks will transition to the ECL framework by April 1, 2027, with a four-year period to adjust provisions on existing loans.
- Assessment of Credit Risk:
- Banks must assess, at each reporting date, if the credit risk of a financial instrument has increased significantly since initial recognition.
- If risk increases, a loss allowance based on lifetime expected credit losses must be made.
- General Approach for ECL Calculation:
- Probability of Default (PD)
- Loss Given Default (LGD)
- Exposure at Default (EAD)
Transitional Adjustments and Staging Criteria
- Transitional Adjustment:
- The difference between the required ECL as of April 1, 2027, and current provisions will be added to the Common Equity Tier 1 (CET 1) capital.
- Staging Criteria for Asset Classification:
- Stage 1: No significant increase in credit risk; 12-month ECL recognized.
- Stage 2: Significant increase but not credit impaired; lifetime ECL recognized.
- Stage 3: Credit impaired; lifetime ECL recognized.
Additional Impacts and Benefits
- Financial Asset Measurement:
- Initial measurement at fair value with transaction costs; subsequent measurement at amortized cost.
- Income recognition will align with the Effective Interest Rate (EIR) method.
- Capital Requirements:
- The one-time provisioning is expected, but minimal impact is anticipated on regulatory capital requirements.
- CareEdge estimates capital adequacy impact up to 30 basis points based on FY25 data.
- Benefits:
- Enhances credit risk management and comparability across financial institutions.
- Aligns with international regulatory and accounting standards.