👍RBI issues draft on expected credit loss-based provisioning by banks – The Hindu BusinessLine

Clipped from: https://www.thehindubusinessline.com/money-and-banking/rbi-issues-draft-on-expected-credit-loss-based-provisioning-by-banks/article66383901.ece

Will bring provisioning requirements for banks on par with those for NBFCs

| Photo Credit: ALTAF HUSSAIN

The RBI has issued a discussion paper on expected credit loss (ECL)-based loan loss provisioning by banks, which when implemented, will bring provisioning requirements for banks on par with those for NBFCs.

The central bank has sought comments and feedback on the paper, from which regional rural banks and smaller co-operative banks will be excluded, by February 28.

“It is proposed that the requirement for estimating impairment losses under the expected credit loss approach would apply to all loans and advances, including irrevocable loan commitments (including sanctioned limits under revolving credit facilities), lease receivables, irrevocable financial guarantee contracts, and investments classified as held-to-maturity or available-for-sale,” said the discussion paper.

The expected credit loss will be measured as a probability-weighted estimate of credit losses (present value of all cash shortfalls) over the expected life of the financial instrument, it added.

The key requirement under the framework will be for banks to classify stressed assets into three categories — Stage 1, Stage 2 and Stage 3, like NBFCs. Banks will be allowed to design and implement their own models for measuring expected credit losses for the purpose of estimating loss provisions, said the RBI.

However, to mitigate concerns regarding model risk and potential variations, the RBI proposed that it will issue broad guidance for designing the credit risk models, define disclosures required by banks, mandate independent validation of the models adopted by banks, and subject banks’ internal assessments to a prudential floor specified by it.

Considering the complexities and time involved in designing and testing the models, banks will be provided sufficient time to implement the norms, RBI said, adding that they will also be allowed to phase out the impact of increased provisions on their CET1 capital till upto 5 years.

“Since the potential initial impact of application of expected credit loss approach on banks’ capital can be expected to be significant, it is proposed to introduce a transitional arrangement for the impact of ECL accounting,” the discussion paper said, adding that the primary objective is to avoid a “capital shock” by giving banks time to rebuild their capital resources.

As per the discussion paper, a loan is proposed to be treated as secured only to the extent of distressed valuation of the security cover not older than twelve months, and be classified as unsecured only if the realisable value is less than 51 per cent of the outstanding exposure.

The paper also proposed that in case of improvement in credit quality, a Stage 3 asset should not be directly brought to Stage 1 but kept in Stage 2 for a minimum of six months, to ensure a cooling period that will facilitate a more realistic assessment of the “unlikeliness to pay” criteria.

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