Lenders with high exposure to the MSME or the unsecured segment are likely to face near-term pressure in terms of provisioning and CET-1 ratios due to the draft expected credit loss (ECL) framework, analysts said.
“The proposed ECL framework will generally require higher provisions across most product segments for banks,” Sachin Sachdeva, vice president, sector head – financial sector ratings, ICRA, said.
“However, the recent significant improvement in asset quality means the overall impact will be less severe… According to ICRA, banks with thinner capital buffers and larger overdue portfolios are likely to face greater challenges during the transition and may need to raise additional capital or utilise the transition period until FY31 to absorb the impact on CET-1 ratios,” he added.
According to a report by Motilal Oswal, top private banks are well positioned for the transition to the proposed ECL model, and it estimates a limited impact on the public sector banks due to their improving asset quality and robust provision coverage ratios.
Last week, the Reserve Bank of India came out with the draft norms for ECL provisioning which will come into effect from April 1. The central bank also gave a five-year glide path for the banks to absorb the one-time impact of higher provisions.
Under the draft guidelines, banks would classify the eligible financial instruments into Stage 1, 2 and 3 assets. The lender will then have to assess if the credit risk on a financial instrument has increased significantly since initial recognition. If so, the bank will have to make a loss allowance, which would be estimated based on the lifetime expected credit losses.
On Stage 1, the bank will have to make 12-month ECL, while on Stage 2 and 3, lifetime ECL would be recognised. The draft guidelines said in case of more than ‘30 days past due (DPD)’, loans would be presumed to incur a significant increase in credit risk (SICR) and would attract lifetime ECL.
For Stage 1 assets, which include performing loans, the provisioning floor is set at 0.4%, broadly in line with current norms for standard assets. Loans to small and micro enterprises will attract a lower floor of 0.25%, while unsecured retail loans will require a higher buffer of 1%.
The real shift comes in Stage 2, which covers loans showing signs of increased credit risk. Here, the RBI has proposed a 5% provisioning floor for most categories. However, certain retail products — home loans, loan against property and gold loans — will see a softer floor of 1.5%, reflecting their relatively lower risk profiles.
For Stage 3 assets, which are considered credit-impaired, the provisioning requirements are broadly aligned with existing non-performing asset (NPA) norms.
“Assuming SMA 1+2 loans at 1–4% for most of the banks, it may attract additional 5–20 bps of provisioning at 5% floor. We believe the additional floor provisioning on Stage 3 would be manageable for most banks,” a report by ICICI Securities said.
Public sector banks have better asset quality compared to their private peers. According to analysts, this would limit the provisioning drag arising from the migration to the ECL framework.
“We are technologically ready for ECL in terms of models, but some adjustments may be required based on the final guidelines”, CS Setty, chairman of State Bank of India, said on the sidelines of the Global Fintech Fest. “Given the long transition time, we believe there will be limited impact on the balance sheet of banks.”
On Tuesday while announcing the Q2 results, Bank of Maharashtra MD Nidhu Saxena said in the 5-year period, the bank has to maintain the ECL provision of Rs 2,500 crore. “We have already started doing ECL provision in our book. As per our estimate, the bank has to maintain Rs 100-125-crore provision every quarter.”
S&P Global Ratings in its recent report said the five-year transition period would give banks time to fine-tune their models, gather data, and smooth out the impact of ECL provisioning on profitability and capital. It also said the higher capital ratios anticipated under Basel III reforms can cushion the ECL provisions.
“We think most banks can accommodate this faster clip while maintaining their asset quality. That said, risks to asset quality could arise from the easy access to funding with lighter covenants tempting corporates to increase leverage,” Shinoy Varghese, global credit analyst at S&P, said.
The guidelines also mention that the upgrade of an asset must have a minimum six-month cooling-off period. According to ICICI Securities, this mandatory cooling-off period could delay upgrade and recovery compared to the current norms. “Our rough estimate suggests loans that slip and get upgraded within the same financial year could be as high at 20–25% for select banks,” it said.