The implementation of expected credit loss (ECL)-based provisioning model proposed by the Reserve Bank of India will be smooth as the transition will hit banks’ balance sheets only one time, a report said. According to analysts at rating agency Icra, this is an important step towards banks’ eventual shift to the Indian accounting standards (IND-AS) regime and the ongoing improvements in their financial metrics should help most of them to transition smoothly to the new framework.
The transition to the ECL model will only have a one-time impact, the agency said without quantifying the same.
Last week, the Reserve Bank of India (RBI) sought feedback on ECL-based loss provisioning model and issued a discussion paper seeking inputs from all stakeholders. The final guidelines are likely to be notified by FY24 for implementation from April 1, 2025.
In February 2016, the RBI had initially notified the implementation of Ind-AS from April 1, 2018 and it had also sought the proforma Ind-AS from banks starting September 30, 2016. However, the implementation was subsequently deferred.
The methodology/basis of computation of ECL is central to Ind-AS and migration to the ECL-based loss provisioning will be a major step towards the eventual shift to an Ind-AS regime for banks, said the agency.
Banks’ non-performing loan ratios are likely to touch decadal lows by March 2024. With further improvement in profitability and capital cushions in the near-term, the timing is apt for banks to implement the ECL-based provisions and given their capital cushion most banks can easily transition to the new regime, it said.
Under the ECL model, loans will be classified as stage 1, 2 & 3, depending on their credit risk profile with stage 2 & 3 loans commanding higher provisions. This is in contrast to the existing approach of the incurred loss provisioning, wherein a step-up provisioning is made based on the duration for which the account has remained dud.
Shifting to the ECL provisioning model will entail a one-time provisioning for stage 2 & 3 loans apart from other off-balance sheet exposures.
While the regulator has proposed a maximum time frame of five years after the date of implementation for spreading out these provisions, the agency expects some banks to raise external capital sooner to manage the impact of the transition in a better manner.
In the discussion paper the RBI has proposed a relaxed classification of 60-plus days past due (DPD) for stage 2 loans as against the 30-plus DPD being followed by most non-banks now. The RBI also asked banks to carry ECL provisions on off-balance-sheet exposures, including undisbursed credit lines.
While the overall ECL provisions will be based on the historical loss patterns observed by banks, the RBI will also specify a minimum floor.
As the provision coverage on existing NPAs (non-performing assets) is reasonably high for the system, the incremental ask on these NPAs will largely remain limited.
Further, of late the overdue wholesale loans have come down significantly, the over-dues in the retail segment have gone up since the Covid pandemic, the report said.