RBI forms working group on ECL provisioning

The Reserve Bank of India (RBI) has decided to form a working group to get independent inputs on the expected credit loss (ECL)-based framework for provisioning by banks. The development comes after the RBI released a discussion paper on the introduction of the "expected credit loss framework for provisioning by banks" on January 16, 2023, seeking inputs from all stakeholders. 

The RBI says the ECL approach to provisioning is a "paradigm shift from the current incurred loss-based provisioning regime". 

The RBI's January discussion paper foresees a "forward-looking, principle-based framework" for the provisioning of credit risk, which has already been implemented under the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB).

"Several comments have been received from various stakeholders on the issues flagged in the Discussion Paper, which are being examined by the Reserve Bank. While the regulatory stance to be taken in respect of each of the issues shall be examined by the Reserve Bank, it has been decided to constitute a Working Group in order to get independent inputs on some of the technical aspects having a bearing on the significant transition involved," the apex bank says in its latest statement.

The working group will be chaired by Prof R Narayanaswamy, former professor, IIM Bangalore, and will consist of domain experts from academia and industry as well as representatives from select banks.

These names include Prof Sanjay Kallapur, ISB, Hyderabad; Rajosik Banerjee, KPMG; S Srinivasa Rao, SBI; Rajendra Khandelwal, ICICI Bank; Susanta Baishya, HDFC Bank; Adish Yadav, Canara Bank; Pravinkumar Taparia, Saraswat Co-operative Bank; and Sridharan N, Equitas Small Finance Bank.

The working group will describe the principles required to be considered by banks, while designing the credit risk models to be used for assessing and measuring expected credit losses. The working group will also recommend factors that banks should consider for the determination of credit risk and suggest the methodology to be used for undertaking external independent validation of the models. 

As per the RBI's earlier discussion paper on the expected loss (EL)-based approach, it'll formulate principle-based guidelines supplemented by regulatory backstops wherever necessary. Further, regional rural banks and smaller cooperative banks are proposed to be kept out of the above framework.

The key requirement under the proposed framework will be for the banks to classify financial assets, primarily loans, including irrevocable loan commitments, and investments classified as held-to-maturity or available-for-sale, into one of the three categories. Banks will also be allowed to design and implement their own models for measuring expected credit losses for the purpose of estimating loss provisions. 

However, to mitigate the concerns relating to model risk and considering the significant variability that may arise, the paper proposed that the RBI will issue broad guidance that will be required to be considered while designing the credit risk models. The guidance will specify detailed expectations on the factors and information that should be considered by banks while making the determination of credit risk.