Why in the news
The RBI has finalised how banks must set aside money for bad loans going forward. Instead of waiting for a default, banks will estimate losses from the day a loan is granted.
Key facts
- Start date: 1 April 2027.
- Phase-in: capital impact spread over four years to 31 March 2031.
- On 1 April 2027 banks must fair value their loan books; the difference goes against retained earnings, not the P&L, to avoid a sudden profit shock.
- The transition impact may be added back to CET1 capital during the transition.
- RBI declined a highly granular uniform manual; each bank must assess its own risk by customer segment and portfolio mix.
- From April 2027, loans are measured at amortised cost using the Effective Interest Rate method, which counts costs such as processing fees.
- The 90-day NPA definition continues.
- Alignment with IFRS 9 improves comparability for global investors.
Old versus new
| Feature | Incurred loss | ECL |
|---|
| Approach | Reactive, after default | Proactive, from day one |
| Data | Historical defaults | Forward-looking macro scenarios |
| Standard assets | Low flat provisioning, e.g. 0.40% | Tiered by stage |
| ROE | Stable but hides risk | Temporary drag from higher initial cost |
Three stages
| Stage | Loans | Provision |
|---|
| 1 | No significant rise in credit risk | 12-month expected loss; minimum 0.4% for corporate and retail |
| 2 | Significant increase in credit risk (SICR), not yet NPA | Lifetime expected loss; minimum 5% |
| 3 | Credit-impaired (NPAs) | Lifetime expected loss |
Computation parameters
- PD: chance the borrower fails to pay in a given period.
- LGD: share of exposure likely lost on default after collateral sale.
- EAD: total exposure at the time of default.
Exam angle
- Standard: ECL aligned with IFRS 9; effective 1 April 2027.
- Know the stage-wise provisioning and PD, LGD, EAD.