The Reserve Bank of India’s three key proposals — the expected credit loss (ECL) framework, liquidity coverage ratio (LCR) norms and project finance proposals – have kept the banking industry on tenterhooks for quite some time.
The guidelines, if implemented in their current format, are expected to increase the provisioning, leading to a rise in credit cost for borrowers by at least 400-500 basis points (bps), said analysts. This, coming at a time, when the interest rate cycle is reversing is worrisome for them. In addition, Finance Minister Nirmala Sitharaman has recently asked banks to cut rates.
The ECL framework alone will impact banks’ core capital by around 300 basis points, say experts. LCR norms are likely to have a 200-250% impact on banks’ net demand and time liabilities(NDTL), experts added.
ICRA in a report said that the impact of the whole transition to IndAS, including the ECL framework, could be as much as 300 to 400 basis points.
LCR guidelines are expected to be rolled out on April 1. Banks have already taken care of the impact of these guidelines by stepping up their purchases of high-quality liquid assets. But with the other two guidelines, banks are still in the stage of transitioning and assessing the possible impact of these guidelines on their core business, said experts.
“RBI is cognizant of the significant impact of these regulatory norms, especially, ECL. Since business growth is coming off they want to smoothen out the impact. The impact seen will be calibrated and will kick in a little late after the implementation. LCR norms will impact some percentage of NDTL but PSUs are already well above the threshold, which is 100%, limiting the impact of LCR guidelines. Private banks are just above the limit, so the impact will be more visible,” said Kanika Pasricha, chief economic advisor at the Union Bank of India.
In the recently-concluded, Monetary Policy Committee meeting, deputy governor, Rajeshwar Rao Governor, in the post-policy conference, highlighted that the central bank has taken a collaborative approach to implementing these guidelines, thereby reducing the impact of these provisions.
“Guidelines are fairly a major game changer as far as the banking system is concerned. We have gotten feedback, which needs to be carefully evaluated as these guidelines will have a significant impact on the banking system. We are close to finalising some of the guidelines,” said Rao.
Senior bankers said that owing to robust growth in profit and banks being adequately capitalised, it is the right time to implement these guidelines. Banking officials said that the move is aimed at improving and strengthening the balance sheet of banks in the long run. Banks have capital adequacy of 200 bps more than what is required under the norms. Therefore, a cushion is already available, said banking officials.
“This is the right time to implement these guidelines as banks are well above the threshold of LCR, profits are quite robust, hence no need for outside capital to strengthen the balance sheet. Some impact will be there on lending but not immediately as RBI has given enough time to adjust to new provisioning requirements,” said a banking official at a state-owned bank.
One challenge to these norms is that banks need to maintain a time series data, and track them on a real-time basis as far as infrastructure financing provisioning and ECL frameworks are concerned, said experts. Moreover, higher provisioning for infrastructure loans may lead to delays in the completion of the project.
Under the ECL framework, banks must estimate potential credit losses based on forward-looking assessments rather than waiting until defaults occur. As part of the new framework, financial assets will be classified into three stages based on their credit risk, with higher provisions required for riskier assets.
While LCR draft guidelines require banks to increase their investments in high-quality liquid assets. Under the guidelines, it has proposed to impose an additional run-off factor of 5% on both stable and less stable retail deposits that are enabled with internet and mobile banking facilities.
Another provisioning guideline proposed by the RBI is draft norms on project finance. Which required banks to set aside 5% as provisions for loans given for infrastructure and real estate projects.
“I think from the regulatory point of view, these are the steps in the right direction. Also, sufficient time is given to banks to adjust to new norms as any expected trade loss will be allowed to be amortised for over a period of 5 years,” said Anil Gupta, senior VP & Co group head of financial sector ratings at ICRA.