Provisioning by banks: RBI considering expected credit loss income method, says RBI deputy governor M Rajeshwar Rao

The Reserve Bank of India is considering a mandate under which banks will be required to switch to the expected credit loss (ECL) income while making provisions, rather than an incurred loss method, in order to better manage the asset quality, Reserve Bank of India deputy governor M Rajeshwar Rao said. Under this system, bigger non-banking financial companies are required to consider the credit loss provision on a forward-looking basis.

Currently, banks are required to make loan loss provisions under the incurred loss model, where the provision is made after the occurrence of default. However, loan default itself being an indicator of stress, the RBI is in the process of issuing a discussion paper on introduction of a framework on expected credit loss for banks, Rao said.

The idea is to formulate principle-based guidelines supplemented by regulatory backstops, wherever necessary. The discussion paper would seek to solicit comments from all stakeholders, including the business community, on the proposed approach, and the final contours or the transition will take into account the feedback received,” Rao said.

Even as the asset quality has improved compared to the pre-pandemic levels and overall banking sector is in a healthy state, banks should take measures to pinpoint whether it has occurred due to improvement in the business fundamentals or due to various dispensations provided during the pandemic period, he said. At the same time, lenders should stress-test their existing loan books and estimate their capacity to absorb losses.

In September 2019, gross non-performing assets (NPA) of the banking system stood at 9.23% while net NPAs were at 3.66%. Compared to that, gross NPAs currently are at 5.97% and net NPAs at 1.7%. Banks’ provision coverage ratio improved from 77% in September 2019 to 86.8% in March 2022.

Although the RBI seeks comfort from the improving asset quality and loan growth, Rao said the central bank has to ensure that the financial system escapes unscathed as the banking system exits from the pandemic-driven regulatory forbearance.

The pandemic also saw the financial sector enjoying favourable momentum with increase in liquidity, flow of credit and normal spending on relief programmes. It is getting increasingly debated in the global fora as to whether the pandemic-induced measures have led to build-up of leverage and debt overhang in the non-financial sector,” he said.

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