Banks start making provisions ahead of RBI’s ECL norms

Subject : Economy

Section: Monetary Policy

In News: Banks begin to build up provisions even before migration to expected credit loss (ECL) based provisioning by RBI.

Key Points:

Reserve Bank of India (RBI) yet to announce the final guidelines on the new expected credit loss (ECL) based provisioning
The ECL moves away from the current incurred loss-based approach.
But banks have started preparing for the change by undertaking higher provisions. Banks are presently basing these (RBI yet to finalise guidelines) on internal assessments.
All banks are likely to start making provisions once the RBI releases the final ECL guidelines.
According to various estimates, the banking sector’s provisioning requirement for shifting to the ECL framework will be between Rs 90,000 crore to Rs 1 lakh crore.

What is the ECL based provisioning?

Under ECL, ‘financial assets’ are to be classified as Stage 1, 2 or 3, depending on their credit risk profile.
Stage 2 and 3 loans have higher provisions based on the historical credit loss patterns observed by banks.
This is in contrast to the existing approach of incurred loss provisioning; whereby step-up provisions are made based on the time the account has remained in the NPA category.

RBI update:

RBI has proposed a maximum time frame of five years after the date of implementation for spreading out these provisions
Additional capital requirements under the ECL framework found within manageable limits.