RBI's ECL norms to reduce Tangible Common Equity for banks by 50-80 bps, says Moody’s

Reserve Bank of India

The proposed regulations for phased implementation of the Expected Credit Loss (ECL) framework for banks by the Reserve Bank of India (RBI) is expected to reduce Tangible Common Equity (TCE) for Indian banks by 50-80 basis points (bps), Moody’s ratings said in a note on October 15.

TCE is a measure of a bank's core equity capital after deducting intangible assets such as goodwill and preferred stock from shareholder equity.

The note said the implementation will be phased over four years, allowing banks to avoid a significant day-one reduction of capital. “Most banks are likely to absorb the decline in capital ratios through more conservative dividend payouts.”

With implementation scheduled from FY28, recent improvements in asset quality will result in lower model-driven ECL provisions, easing overall capital reduction from the transition, said the ratings agency.

Moody's further added that banks with a longer track record of consistent asset quality will benefit from lower model based ECL estimates, but these are capped by provisioning floors which act as a safeguard against under-provisioning and model risk.

Expected Credit Loss (ECL) framework of provisioning for bad loans, with prudential floors, is proposed to kick in from April 1, 2027, the Reserve Bank of India (RBI) Governor Sanjay Malhotra said on October 1 during the monetary policy announcement. The norms will be applicable to Scheduled Commercial Banks (excluding Small Finance Banks (SFBs), Payment Banks (PBs), Regional Rural Banks (RRBs)) and All India Financial Institutions (AIFIs), the Governor had said.

Read More: Bank of Maharashtra pegging quarterly ECL provision at Rs 100-125 crore, says CEO Nidhu Saxena

The guidelines are expected to enhance credit risk management practices and promote better comparability of reported financials across institutions. The framework is designed to be implemented in a non-disruptive manner with a suitable glide-path, the RBI said during its October 1 MPC statement.

The ECL model, proposed by RBI, has mandated that banks must recognize stress much earlier, in contrast to the existing regime in which they make provisions after losses are incurred.

The guidelines require banks to classify financial assets into three stages based on credit risk. Stage 1 assets will be provisioned at 12-month ECL; Stage 2 assets at lifetime ECL for significant increase in credit risk; and Stage 3 assets at lifetime ECL for credit-impaired exposures.