The expected credit loss (ECL)-based regime for loan provisioning that is proposed to come into effect from April 2025 and the transition to the framework will have a unique impact on the capital of banks, according to ICRA Ratings.
The Reserve Bank of India, on January 16, issued a discussion paper proposing a change in banks’ provisioning requirements from an ‘incurred loss’ approach to the ECL approach. The central bank requested feedback and comments on the document by February 28.
“Following the precedent, ICRA expects the final guidelines to be notified by fiscal year 2024 for implementation from April 1, 2025,” the rating agency said. Banks with a higher proportion of restructured loans, past due loans (dpd) of more than 60 days and off-balance sheet exposures will see a greater impact, while those with lower capital buffers will need to raise capital to manage the transition, ICRA said.
Banks’ non-performing asset (NPA) levels are likely to hit 10-year lows by March 2024. With further improvement in profitability and capital buffers in the near term, the time is right to for banks to implement ECL-based provisions, Aashay Choksey said. , Vice President and Head of Sector – Financial Sector Ratings, ICRA.
In February 2016, the RBI notified the implementation of the Ind-AS framework from April 2018. However, it was postponed several times.
Under the ECL framework, advances will need to be classified as Stage 1, 2 or 3, based on their credit risk profile, and Stage 2 and 3 loans will have higher provisions based on historical credit loss patterns. This is in contrast to the existing ‘incurred loss provisioning’ approach, where provisions are increased based on the length of time the account has been in the NPA category.
The RBI has proposed up to five years to extend the additional provisions, but ICRA expects some banks to raise external capital sooner to manage the impact of the transition.
“While wholesale non-performing loans from banks have been reduced significantly, non-performing loans in the retail segment have increased after the start of the Covid-19 pandemic. Our discussions with some banks indicate that the impact of the transition to IND-AS could be as much as 300-400bp, including the provision for ECL,” Choksey said.
