The banks will have to make provisions for delays made by borrowers in their repayments under the proposed framework, in addition to existing provisioning requirement.
The Reserve Bank of India on Monday released the draft guidelines for banks to make provisions on an expected credit loss (ECL) basis as against the current framework of incurred loss method. The RBI has proposed that banks will be allowed to design own credit loss models and spread the higher provisions over a five-year period under a newer system of setting aside money for lending. However, banks are free to choose a shorter transition period.
The banks will also have to make provisions for delays made by borrowers in their repayments under the proposed framework, in addition to existing provisioning requirement. This may lead to increased provisioning as the lenders will have to calculate estimated loss of interest income and provide for them. Under the current norms, the banks make provisions for loans after the loss of interest income is incurred.
The RBI has sought feedback on the issues by February 28.
The measures will be applicable to banks’ loans and advances, including sanctioned limits under revolving credit facilities, lease receivables, financial guarantee contracts and investments in the debt and equity markets.
Banks will be given a free hand to design their own models for measuring ECL based on the guidelines given by the RBI. If a lender has outsourced its validation to an external entity, the bank will be responsible for the validation work. The ECL estimates will be subject to a prudential floor prescribed by RBI as a regulatory backstop, the RBI said.
The discussion paper said banks will have to classify financial assets, including primarily loans, irrevocable loan commitments, and investments classified as held-to-maturity or available-for-sale, into one of the three categories – Stage 1, Stage 2, and Stage 3, depending upon the assessed credit losses on them.
The central bank has proposed that banks will have to consider lifetime ECL if the credit risk on the financial asset has increased significantly since initial recognition.
In case the financial health of the account has not deteriorated, lenders will have to recognise 12-month ECL.
The central bank has also proposed that an asset in Stage 3 shall not directly be brought to Stage 1 even after the irregularities are rectified. Banks will have to classify a Stage 3 asset in Stage 2 for a minimum of six months after all irregularities are rectified, and then bring it to Stage 1. The restructured assets performing satisfactorily will be subject to a fixed prudential floor for loss provisioning regardless of the time spent as a Stage 3 asset.