WHY INDIAN COMMERCIAL BANKS NEED TO ADOPT EXPECTED CREDIT LOSS (ECL) BASED PROVISIONING APPROACH?

Paper Number :No. 1/2023
Publication Date :Jan. 31, 2023

Reserve Bank of India has recently proposed to adopt the Expected Credit Loss (ECL) approach used in International Financial Reporting Standards (IFRS 9). The central bank has released a discussion paper on 'Expected Credit Loss' model for loan loss provisioning by the commercial banks in India. Banks are currently making provisions after assets are identified as impaired or non-performing as per this regulatory definition. Under current accounting norms for banks and FIs, the quantum of provisioning is also specified by the regulator. However, provisioning under this approach has been criticized for being too little, too late. RBI's proposal for introducing expected credit loss-based provisioning by banks would be to formulate principle-based guidelines supplemented by regulatory backstops wherever felt necessary. The provision amount would be based on current internal risk estimate of potential future credit loss. Expected loss is applicable for both assets which are currently impaired (but exact loss amount is uncertain) and those which are currently performing, but may face impairment in the future.