Banks and ECL norms
On October 7, the Reserve Bank of India (RBI) issued the draft Reserve Bank of India (Scheduled Commercial Banks-Asset Classification, Provisioning
and Income Recognition) Directions, 2025 for public comments. These directions are proposed to be implemented by banks and financial institutions with effect from April 1, 2027 – a possible indicator that banks and financial institutions will transition to Indian Accounting Standards (Ind AS) from this date.
The draft directions have been structured on Ind AS 109 on financial instruments in general and the 90-day mantra in particular. A bank shall classify a financial asset as non- performing assets (NPA) if interest and/or principal remains continuously overdue for a period of more than 90 days in respect of a term loan, bills purchased and discounted and OD/CC accounts.
A credit card account where the minimum amount due, as mentioned in the statement, is not paid fully within 90 days from the payment due date mentioned in the statement would be classified as NPA.
Agricultural loans would be classified and provided for based on the duration of the crop season. NPAs shall be classified into sub-standard, doubtful and loss asset depending on the period they have remained in a category.
Banks shall use a general approach consisting of three key functions i.e. Probability of Default (PD), Loss Given Default (LGD) and Exposure at Default (EAD) to measure expected credit loss (ECL).
The Directions contain certain broad principles to be followed by a bank for ensuring prudence and robustness while using models in the process of ECL computation. A bank shall recognise lifetime ECL for all financial instruments evidencing significant increase in credit risk (SICR) since initial recognition.
For this purpose, a bank shall adopt a three-stage approach, based on the credit quality of the financial instrument at the time of initial recognition, or on any subsequent reporting date.
For loans and similar financial assets, a credit loss is the difference between the present values of the contractual cash flows that are due to the bank under the contract and the cash flows that the bank expects to receive.
Banks and financial institutions would be transitioning to Ind AS nearly a decade after India Inc transitioned to Ind AS. It was generally felt that RBI was delaying the implementation of Ind AS for banks since the concept of Fair Value for the treasury portfolio and the ECL model to provide for non- performing assets could dent the financials of any bank.
The Directions propose another solution to cushion the banks from the impact of Ind AS. It has been decided to introduce a transitional arrangement for the impact of ECL based provisioning on regulatory capital by giving banks time to rebuild their capital resources following a possible negative impact arising from the introduction of ECL accounting.
The transitional adjustment amount – the difference between the ECL required as on April 1, 2027 (computed based on the balance sheet position as on March 31, 2027), and the provisions held as per the extant IRACP norms as on March 31, 2027 -may, at the option of the bank, be added back to the Common Equity Tier 1 (CET 1) capital. This benefit shall be provided till March 31, 2031. A bank may choose to spread the transition over a shorter period.
These Directions could be officially notified soon along with other requirements of Ind AS standards. Banks would need to rejig their Core Banking System (CBS) and MIS data.
Since the ECL model is based on the expected cash flows, provisioning will trickle down to the branch level. Auditors of banks and their branches would need to learn the new model and unlearn the old norms. RBI seems to have covered all bases to ensure that the impact of the transition is minimal. The insurance regulator IRDAI is expected to follow suit and issue a similar set of guidelines for insurance companies. As the saying goes “Better late than never”.
