‘Expected credit loss’ framework can wait

At present, all commercial banks make provisions for their loan assets only as and when evidence of loss is sighted (incurred loss basis). Now, the RBI is mulling the introduction of Expected Credit Loss (ECL) framework, and a discussion paper on this is likely to be released soon.

The RBI perhaps feels obligated to comply with the Bank for International Settlements (BIS) norms in this matter, to ensure global convergence.

The concept of ECL is not new. It was floated in April 2018 as a part of Indian Accounting Standard. But IndAS was deferred, mainly on account of the fact that the banking system was not prepared to implement it at that point of time. The ECL framework also suffers from a weakness — it aims to reckon the loss (on account of a particular loan) by finding the probability of default (PD) based on historical behaviour, whereas in reality the servicing pattern of a loan is not uniform throughout its currency and is bound to move for better or worse depending upon the borrower’s cash flow.

Setting aside the pluses/minuses of this concept (as it is too early to discuss at this stage), the moot question is: Does the RBI think that our banks are geared up for moving to the ECL framework?.

Curiously enough, as per the extant guidelines of the RBI, banks are now required to make provision for non-performing assets at 15-100 per cent of the outstanding balances depending upon the status of overdue position — that is, sub-standard/doubtful or loss, besides 0.15-1 per cent for all “standard assets”. In a way, this provision made by banks for these performing assets is also meant to meet the ‘deemed credit loss’.

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Green shoots seen

Coming to the decision with regard to ECL, it is to be borne in mind that only now banks are showing an uptrend in their business growth after the ravage caused by the pandemic in the last two years.

The RBI’s Financial Stability Report of June 2022 reveals that the annual growth in bank credit reached 13.1 per cent in June, a rate last recorded in March 2019.

Business enterprises, particularly MSMEs which reached a nadir during Covid times, are now showing significant signs of revival thanks to the huge funding by banks (₹2.36-lakh crore up to April) under the Emergency Credit Line Guarantee Scheme floated by the government/RBI.

The economy is back on the rails now, and it is the right time for banks to ensure steady credit growth, making use of the flourishing business opportunities.

At this juncture, introduction of ECL, which will be complex in structure, will not only divert the focus of banks on rapidly redeeming their business but will also affect their bottomline, which is becoming steady now.

The FSR reveals that the RBI will not have any apprehension over the adequacy of the existing provisioning norms or of any capital erosion in banks in the long run. The Risk Management Department of all banks is proactively undertaking stress tests of their loan books under different scenarios to check how far their CRAR (capital to risk weighted assets ratio) gets impaired.

Also, credit sensitivity analysis is done by the RBI on a different scale. The recent FSR says that a severe stress test of the credit portfolio of 46 select banks (where perhaps the GNPA ratios are not comfortable), by applying 2 SD (standard deviation) shock, showed that the GNPA ratio moved up from 6 per cent to 11.5 per cent and the CRAR declined from 16.5 per cent to 12.6 per cent — that is, still a solid 3.6 per cent over the prescribed level of 9 per cent.

Further, real time marking of NPAs is being religiously done by all banks subsequent to the RBI circular issued in September 2021. To spot the stress in loans before they actually become bad, the status of overdue position is captured under three levels — Special Mention Account (SMA) 0, SMA 1 and SMA 2 — and timely steps are taken by banks to put them on the right track.

Let’s wait and watch

At a time when we are witnessing an uptick in the performance of banks after the Covid disaster, it may not be advisable to change the existing provisioning framework, a crucial factor which determines the net profit of banks.

Perhaps the restructured loan portfolio, which runs to ₹46,186 crore (March 2021 scheme), weighs heavily on the RBI as it may be deemed a potential threat. But the restructured loan assets, though standard, also carry a provision of 10 per cent as a buffer.

Given the economic recovery being witnessed now, the RBI will do well to defer its decision on introducing the ECL framework.

The writer is former chairman, City Union Bank Ltd