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RBI Sets Up Working Group On Framework For Expected Credit Loss Provisions

The nine-member working group will be chaired by R Narayanaswamy, former faculty at IIM Bangalore.

<div class="paragraphs"><p>(Source: Vijay Sartape, BQ Prime)</p></div>
(Source: Vijay Sartape, BQ Prime)

The Reserve Bank of India has formed a working group for recommendations on provisioning by banks based on the expected credit loss (ECL) framework, the central bank said in a press release on Wednesday.

The nine-member working group will be chaired by R. Narayanaswamy, former faculty at IIM Bangalore.

ECL provisioning refers to the practice followed by banks and financial institutions to set aside a portion of their earnings as a provision to cover potential losses arising from non-performing assets.

The central bank released a discussion paper on the ECL framework in January this year for better assessment of asset quality and credit impairment. This is a deviation from the current norm of building provisions after the occurrence of a loan default.

All scheduled commercial banks, except regional rural banks, are considered to be brought under the ECL provisioning framework.

If the risk of default rises, banks will be required to set aside a provision equivalent to the estimated lifetime credit losses. Currently, the banks provide it after a borrower fails to repay the loan for over 90 days.

The benefits of ECL-based provisioning would be phased out over five years, the RBI said in its discussion paper. "The primary objective of such a transitional arrangement is to avoid a “capital shock” by giving banks time to rebuild their capital resources following a probable negative impact arising from the introduction of ECL accounting," the central bank said.

Earlier, the RBI had said that ECL-based provisioning would be introduced during 2023–24 as part of its efforts to bolster the bad loan resolution system. However, the banks have asked the central bank for more time to implement ECL-based provisioning.

The terms of reference for the working group, as detailed by the RBI, are as follows:

  • Elaborate on the principles that must be considered by banks while designing the credit risk models to be used for assessing and measuring expected credit losses.

  • Recommend factors that banks should consider for determining credit risk.

  • Suggest the methodology to be used for undertaking external, independent validation of the models.

  • Recommend, based on comprehensive data analysis, prudential floors for provisioning.

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