Transition to expected credit loss-based provisioning may hit banks only one time: Icra

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The Reserve Bank of India’s proposal to implement expected credit loss (ECL)-based loss provisioning by banks could lead to a transitioning impact of 300-400 basis points, including the provisioning for ECL, while shifting to the IND-AS accounting system, a report said.

Banks with higher share of restructured loans, 60 days past dues (DPD) loans and off-balance sheet exposures will see higher impact while those with lower capital cushions would need to raise capital to manage transition, according to rating firm ICRA.

“Decadal low NPA levels, coupled with improved profitability and capital position, could help most banks absorb the impact,” it said. Further, while the overdue wholesale loans of banks have reduced significantly, the overdues in the retail segment have increased post the onset of the Covid-19 pandemic.

The RBI discussion paper on ECL has proposed a relaxed classification of 60 days past due standard loans as a part of Stage 2 loans (30 days past dues followed by most non-banks at present) and also asked banks to carry ECL provisions on off-balance sheet exposures, including undisbursed credit lines. While the overall ECL provisions will be based on the historical loss patterns observed by banks, the RBI will also specify a minimum floor, the ICRA report said.

ICRA expects the ECL-based loss provisioning by banks to be an important step towards their eventual shift to the Indian Accounting Standards (IND-AS) regime. The improvement in the financial metrics should help most banks transition smoothly to the new framework, it said.

Going by precedent, ICRA expects the final guidelines to be notified by FY2024 for implementation from April 1, 2025.

In February 2016, the RBI had initially notified the implementation of IND-AS from April 1, 2018 and it had also sought proforma IND-AS from banks starting September 30, 2016. However, the implementation of IND-AS was subsequently deferred.

The methodology/ basis of computation of ECL is central to IND-AS and migration to ECL-based loss provisioning will be a major step towards the eventual shift to an IND-AS regime for banks.

Aashay Choksey, Vice President & Sector Head – Financial Sector Ratings, ICRA said: “The non-performing advances (NPA) levels of banks are likely to touch decadal lows by March 2024. With further improvement in profitability and capital cushions in the near term, we believe the timing is apt for banks to implement the ECL-based provisions.”

“As the provision coverage on existing NPAs is reasonably high for the banking system, the incremental ask on these NPAs will largely remain limited,” he said.

Under ECL, ‘financial assets’ are to be classified as Stage 1, 2 or 3, depending on their credit risk profile with Stage 2 and 3 loans having higher provisions based on the historical credit loss patterns observed by banks. “This will be in contrast to the existing approach of incurred loss provisioning, whereby step-up provisions are made based on the time the account has remained in the NPA category,” ICRA said.

Shifting to ECL-based provisioning would entail a one-time provisioning requirement on such Stage 2 and 3 exposures apart from other off-balance sheet exposures, ICRA said. While the RBI has proposed a maximum time frame of five years after the date of implementation for spreading out these provisions, ICRA expects some banks to raise external capital sooner to manage the impact of the transition in a better manner, it said.