RBI proposes banks to design own credit loss models

In addition to the current provisioning obligation, the new framework will compel banks to make provisions for borrowers' late repayments.

The draught rules for banks to make provisions on a "anticipated credit loss" (ECL) basis, as opposed to the present framework of "incurred loss," were announced by the Reserve Bank of India on Monday. The RBI has suggested that banks be permitted to create their own credit loss models and spread the higher provisions over a five-year period under a new approach of putting aside money for lending. Banks may, however, choose for a shorter transition time.

Under the proposed framework, banks would also be expected to make provisions for borrowers' late repayments in addition to the current provisioning obligation. Due to the lenders' need to estimate and account for their expected loss of interest revenue, provisioning may rise as a result.

As of right now, banks make loan provisions when they suffer a loss of interest revenue.The RBI has asked for comments on the problems by February 28.The regulations will apply to loans and advances made by banks, as well as sanctioned limits under revolving credit facilities, leasing receivables, financial guarantee contracts, and investments in the debt and stock markets.

Based on the RBI's instructions, banks will be permitted to create their own methods for calculating ECL. The bank will be in charge of the validation process if a lender has contracted out its validation to an outside party. According to the RBI, a prudential floor has been established as a regulatory backup for the ECL estimations.

According to the discussion paper, banks will have to divide financial assets into one of three categories—Stage 1, Stage 2, or Stage 3—depending on the assessed credit losses on them. These assets will primarily include loans, irrevocable loan commitments, and investments classified as held-to-maturity or available for sale.

If the credit risk associated with the financial asset has considerably grown since first identification, the central bank has suggested that banks take lifetime ECL into account.Lenders must acknowledge the 12-month ECL when the account's financial situation hasn't worsened. 

Additionally, the central bank has suggested that even if the anomalies are corrected, an asset in Stage 3 not be immediately transferred to Stage 1. After all errors have been fixed, banks must categorise Stage 3 assets in Stage 2 for at least six months before moving them to Stage 1. Restructured assets that perform adequately will be subject to a fixed prudential floor regardless of how long they remain Stage 3 assets.