The Reserve Bank of India’s (RBI) move on September 30 saying it will introduce a discussion paper seeking comments on whether banks should follow the Expected Credit Loss (ECL) model to make provisions will lead to sustainable growth for banks at a time when credit growth is booming, senior bankers say.
Ensuring higher provisions and recognising stress upfront prevent banks from falling into a crisis, RBI Governor Das said today, referring to the Global Financial Crisis of 2018.
“The inadequacy of the incurred loss approach for provisioning by banks and its procyclicality, which amplified the downturn following the financial crisis of 2007-09, has been extensively documented,” Governor Das said.
“One of the major elements of the global response to these findings has been a shift to the Expected Credit Loss (ECL) regime for provisioning,” he added.
As per RBI’s latest data, banks’ outstanding non-food credit grew 16 per cent year-on-year (YoY) to Rs 124.30 lakh crore as on August 26, higher than the 6.7 per cent growth registered a year ago.
“Economic activity remains strong and private consumption is showing good signs,” Murali Ramakrishnan, Managing Director and Chief Executive Officer (MD and CEO) at South Indian Bank, told Moneycontrol.
Even the large industry segment, which posted a 2.6 per cent degrowth last year, has registered a credit growth of 6.4 per cent during August, RBI data showed.
Asked whether the ECL-based model for stress recognition will lead to incremental growth problems and what impact it would have on banks’ provisions going ahead, Ramakrishnan said this was an “interesting suggestion” from the regulator, but the bank will need to look at the fine print to understand the impact in detail.
“The ECL approach results in the early recognition of potential credit losses because it includes, not only losses that have already been incurred, but also expected future credit losses – it is a forward-looking model,” Suresh Khatanhar, Deputy Managing Director at IDBI Bank, said.
“The ECLs at all times, recognise past events, current conditions and forecast information to estimate the loss. This provision will make the system robust and enhanced due diligence will enable more productive growth with risk mitigated approach,” the IDBI Bank DMD said.
Currently, as per RBI norms, NBFCs follow the ECL model to recognise stress and create provisions.
Anil Gupta, Senior Vice President at rating agency ICRA, said RBI’s move is a “stepping stone” for banks to move towards the IND-AS regime of accounting.
“As a stepping stone towards IND-AS, ECL-based provisioning approach is expected to be implemented for banks,” Gupta said.
“While we await the draft guidelines from RBI, in our view, with improved capital position, along with high provision cover on NPAs, banks are likely to be well-positioned to take incremental hit, if any, on their capital because of increase in provisions on their standard, as well as overdue loans,” he added.
Prakash Agarwal, Director, and Head of Financial Institutions at India Ratings & Research, says as RBI makes progress on the ECL-based approach for loan loss provisioning by banks, some banks may start building buffers in provisions to smoothen the transition.
“Having said that, at the system level, a rise in provision is unlikely to be significant considering that the corporate stress cycle has mostly played out and banks have been making materially higher provisions than prescriptive norms. Additionally, the incremental slippages in the system are likely to trend lower,” Agarwal said.
Loan rates to rise faster
As per bankers, nearly half of the outstanding loans will see an increase in interest rates immediately by 50 basis points (bps) as they are linked to an external benchmark. The pace of deposit rate hikes will be slower, but is surely in the offing, they add.
“Interest rates for the external benchmark-linked rate (EBLR) loans are set to go up immediately due to the increase in repo by 50 bps. Banks have already started repricing their FDs (fixed deposits) and CDs (certificate of deposits) keeping in mind the increased demand for deposits,” Ramakrishnan said.
“The rise in credit growth and the measures from the central bank to curb inflation are also putting pressure on banks for increasing their deposit rates. The bulk deposit rates of many banks are now already above their retail term deposit rates,” he added.
Per Agarwal, while banks’ deposit rates are likely to increase faster in the rest of the financial year, as systemic liquidity tightens, the rise still is likely to be calibrated, lagged and lower than the repo rate rise, Agarwal said.
“Nevertheless, loan growth, especially long tenor ones such as mortgages which have been witnessing strong growth could face headwinds as the increase in instalments become material,” Agarwal said.
Going ahead, as per Madan Sabnavis, Chief Economist at Bank of Baroda, a further 50-60 bps increase in repo rate is likely in the coming months.“Inflation will be the chief driving factor as there are some upside risks to the number of 6.7 percent (CPI) due to developments on the agricultural side,” he said.