Reserve Bank of India (RBI) Governor Shaktikanta Das on September 30 said the central bank will soon release a discussion paper seeking industry opinion on whether banks should follow the expected credit loss (ECL) model for loan loss provisions, instead of the incurred loss model.
“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,” Das said. “One of the major elements of the global response to these findings have been a shift to expected credit loss (ECL) regime for provisioning.”
As per RBI’s 2012 paper on loan loss provisions, current accounting standards based on incurred loss approach do not permit recognizing credit losses based on events that are expected to occur in the future. Under the ECL model though, capital has to be set aside before the loan turns into NPA.
Banks ascertain their loan book’s quality by considering a mix of factors, including what is the total exposure of bank to risky sectors, total number of special mention account (SMA) loans which are essentially the overdue loans, among others.
Lack of adequate provisions can prove fatal for banks, as was seen in the case of YES Bank and Lakshmi Vilas Bank, among others, analysts say.
“As a further step towards converging with globally accepted prudential norms, it is proposed to adopt expected loss approach for loss allowances required to be maintained by banks in respect of their exposures,” Governor Das said today.
“As a first step, a discussion paper on the various aspects of the transition will be issued shortly,” he added.
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