The Reserve Bank of India on Tuesday issued a draft circular on the expected credit loss (ECL) framework. The proposed guidelines will replace the incurred-loss-based provisioning framework with an ECL-based provisioning, where they have to classify financial assets into different stages depending on the assessed credit losses at the time of initial recognition and on the further reporting dates.
“These directions are expected to further strengthen credit risk management practices, promote greater comparability across financial institutions, and align regulatory norms with internationally accepted financial reporting norms,” said RBI.
Introduction of Staging Criteria for Asset Classification
The central bank introduced staging criteria for asset classification under the ECL approach, while retaining the extant norms for Non-performing Asset (NPA) classification. A financial asset is said to be under stage one when it does not have a significant increase in credit risk (SICR) till maturity or has low risk, and 12-month ECL will be recognised. A loan will be categorised as stage two when it has had a SICR since initial recognition but is not considered to be ‘credit impaired’. Finally, loans will come under stage three when it is considered to be ‘credit impaired’ at the reporting date. Stage two and stage three will carry lifetime ECL provisioning.
For instance, unsecured retail loans will face a higher provision at 1% in stage one and 5% in stage two. Project finance will have a provisioning of 1.25% at the construction phase and 1% in the operational phase.
Though the new ECL guidelines will cause additional one-time provisioning for banks, the central bank iterated overall impact on the minimum regulatory capital requirements will be minimal. RBI also proposed a five-year glide-path till March 31, 2031, which will help facilitate the transition in a non-disruptive manner.
The RBI proposed to calculate interest income for financial assets such as loans by applying the
effective interest rate to the gross carrying amount of a financial asset during stage 1 and stage 2. It also suggested adopting a risk-based model tiering process to classify models according to their risk and output.
Transitional Arrangement to rebuild Capital Resources
To help banks rebuild their capital resources from the negative impact caused by the new norms, the central bank decided to introduce a transitional arrangement. The transitional adjustment amount must be included in CET1 capital each year during the transition period, the RBI said.
The RBI also proposed changes to the way banks assign risk weightage to loans. It introduced a granular risk weight treatment for exposure to corporates, MSMEs, and real estate. It also made some adjustments to the risk weights applied to loans rated by credit rating agencies, depending on the default history of such loans. This will positively impact the minimum regulatory capital requirements of banks.
The new guidelines will come into effect from April 1, 2027. The central bank has invited comments till November 30.