Can RBI’s new provisioning framework make Indian banks more resilient to future shocks?

In view of significant changes in global standards and best practices, there was a pressing need to change the existing asset classification, provisioning, and income recognition norms in India. Accordingly, the Reserve Bank of India (RBI) has issued Draft Directions on Asset Classification, Provisioning and Income Recognition for Comments (referred to as ‘the draft directions’), which will apply to all Scheduled Commercial Banks (SCBs) in the country, effective April 1, 2027.

These directions envisage a shift from the incurred loss model to the expected credit loss (ECL) model, aimed at reducing pro-cyclicality in the banking sector and introducing the concept of effective interest rate (EIR) for loan interest income. Under the incurred loss model, banks generally provide for advances only when defaults occur, which are often higher during economic downturns. This does not ensure real-time provisioning and eventually poses a risk in terms of destabilising the entire ecosystem during recession cycles. The ECL model, on the other hand, aims to build real-time provisioning promptly, even in better times, thus helping banks absorb shocks and maintain credit flow even in slower phases.

Considering the significant judgements involved in the implementation of ECL norms, RBI has chosen the conservative path by retaining the concept of NPAs and introducing the concept of prudential floor. It requires banks to provide a higher prudential floor and ECL as computed by the management. 

This is in addition to guidelines that prescribe floor rates for probability of default (PD) and a high regulatory loss given default (LGD) of 65-70% where it cannot be reliably estimated.

Further, considering that the transition to ECL requirements may have a significant impact on the capital adequacy for some banks, RBI has provided an option to adopt a five-year ‘glide path’ to manage the initial impact on capital.

RBI, in its draft directions, has introduced the concept of EIR, where the income from financial assets will be recognised using the EIR method, ensuring that income is recognised in line with the asset's yield over its life. This approach provides a more accurate representation of income and aligns with Ind AS.

However, some aspects need to be clarified in the final directions, some of which are highlighted below:

a) What is the prescribed accounting treatment for the opening impact on implementation of the ECL framework (e.g., adjustment through retained earnings or Profit & Loss Account)?

b)  Whether undue cost and effort will be an overarching principle for all aspects of the first-time implementation of these guidelines. For instance, while doing EIR computation for the existing portfolio on the date of transition, a bank may be facing significant challenges in past data about processing fees at the account level.

c)  Will EIR be recomputed in case there is a change in expected cash flows due to some change in interest rates or prepayments, etc.? If yes, whether it will be prospectively or retrospectively?

d) Under the existing IRAC norms, some banks maintain contingent provisions. Upon transition to the expected credit loss (ECL) framework based on RBI draft directions, will the applicable guidelines permit reversal of such contingent provisions if the management believes the same is no longer required under the ECL framework? If so, should the resulting impact be adjusted through the General Reserve or through any specific or restrictive reserve?

e)  RBI draft directions require the constitution of a subcommittee of the board/board-approved committee consisting of the chief financial officer (CFO) and the chief risk officer (CRO). Clarification may be sought on whether other functional heads—such as those from credit, risk, finance, and IT—may also be included as members of this subcommittee to facilitate a smoother transition and effective monitoring of ECL implementation?

Banks are encouraged to provide comments on the draft master directions on any other clarifications that may be required. The last date for comments is November 30, 2025.

EY’s outlook

The transition to the ECL framework presents an opportunity for the banks to integrate their financial reporting with enhanced credit risk management practices and align with international standards. This will also help them in advanced credit policy, improved collection efficiency, and more effective portfolio monitoring.

In this context, the banks will have to primarily focus on the next steps as follows:

a) Forming an ECL steering committee/sub-committee comprising the CFO and CRO.

b) Define roles and responsibilities of CFO, CRO, and other stakeholders, such as credit and IT, in ECL governance.

c) Conduct an impact assessment study covering data gaps.

d) Develop/fine-tune current ECL methodology.

e) Upgrading IT systems and evaluating the impact of ECL on its financials.

f) Policies & procedures and governance model to be established.

g) Evaluate disclosure requirements in financial statements

h) Consideration of modelling overlays and management overlays

i) Continuous process improvement through upgradation of data, refining models, systems and disclosures.

The implementation of directions will require significant changes in the governance framework, policies and processes, and technological enhancements. It will also impact profitability, reserves, capital adequacy ratios, and enhanced reporting requirements. Hence, the banks will have to gear up the implementation of systems, policies, and processes to ensure compliance with the guidelines by April 2027.

To summarise, the regulator has taken bold steps towards convergence with global reporting practices through ECL customised provisioning norms by retaining concepts of extant prudential norms and principles of conservatism. With these draft directions, the RBI is signalling a structural upgrade of India’s loan-loss provisioning regime—bringing it more into line with global best practice while maintaining supervisory safeguards tailored to the Indian context. As the credit cycle evolves, this change could help Indian banks become more resilient, improve their readiness for future stress, and support a steadier flow of credit—provided the transition is managed well.

(The author is Partner, Financial Accounting Advisory Services, EY India. Views are personal.)