RBI Releases Draft Guidelines For ECL Transition And Revised Risk Weight For MSME, Retail Segments

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Motilal Oswal Report

The Reserve Bank of India has issued draft guidelines for two important measures that it announced in the recent monetary policy:

Transition to the expected credit loss framework for all scheduled commercial banks (excluding small finance banks, private banks, and regional rural banks) and All India Financial institutions from April 01, 2027, with a glide path till FY32 to absorb the one-time impact of higher provisions.

The RBI has proposed retaining the existing 90+ days past due NPA definition and introduced Stage 1/2/3 classification based on credit risk (with ≥30 DPD as the Stage-2 backstop).

It has also introduced model-based provisioning (PD×LGD×EAD) anchored by regulatory floors to ensure adequate provisioning.

Additionally, the RBI has also announced the draft guidelines for the credit risk capital framework to enhance the risk sensitivity of the banking system and align it with the revised Basel III standards.

The new guidelines, effective April 01, 2027, aim to bring greater granularity and consistency in computing risk-weighted assets by refining sectoral risk weights and linking them to borrower ratings, project stages, and loan-to-value ratios, ensuring a more accurate reflection of underlying credit risk across asset classes.

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The transition to the ECL framework will increase provisioning requirements, as potential losses on standard and off-balance-sheet exposures get recognized earlier, creating near-term pressure on capital and profitability.

Banks may see a temporary RoA drag due to higher credit costs, though the phased rollout by FY32 will cushion the initial hit. Private banks, supported by stronger capital buffers, advanced data systems, and mature risk models, are better positioned to manage the shift, whereas PSBs with negligible contingency buffers and higher MSME exposure could face some additional provisioning requirements. Over time, the ECL framework will enhance earnings stability, transparency, and comparability, strengthening the system’s resilience.

In parallel, the revised credit risk capital norms, linking risk weights to borrower ratings, project stages, and LTV ratios, will promote prudent lending and efficient capital use. While recalibrations may cause temporary differences in capital ratios, lower risk weights on housing, MSMEs, and rated corporates will support credit growth and boost capitalization ratios, making the overall impact neutral to positive for well-capitalized banks.

We maintain our positive view on the sector, with ICICI Bank, HDFC Bank, SBI and AU Small Finance Bank as our preferred picks.

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