RBI to introduce expected loss approach for bad loan provisioning in fiscal 2023-24

MUMBAI: The RBI is proposing to introduce expected lossbased approach for provisioning during 2023-24 as part of its measures to strengthen the bad loan resolution ecosystem.

This will enable banks to design their own credit loss models and spread the higher provisions over a five-year period under a newer system of setting aside money for lending.

“In addition, the finalisation of guidelines on the securitisation of stressed assets, and a comprehensive review of the prudential framework (including the guidelines on the resolution of stress in respect of projects under implementation) are also likely to be undertaken during the year with the objective of further strengthening the resolution ecosystem.

“...policy measures, such as guidelines on the introduction of expected loss-based approach for provisioning are likely to be announced during 2023-24,” RBI said in its Annual Report 2022-23.

The RBI in January this year released a discussion paper on the expected loss-based approach for provisioning.

The banks will have to classify financial assets, including primary loans, irrevocable loan commitments and investments classified as held-to-maturity or available-for-sale, into one of the three categories - Stage 1, Stage 2, and Stage 3, depending upon the assessed credit losses on them, as per the discussion paper.

It said that the classification will have to be done at the time of initial recognition as well as on each subsequent reporting date, and banks will have to make necessary provisions.

While the Reserve Bank of India proposes to leave it to banks to design the model, its paper said there is a list of mitigant concerns relating to model risk and considering the significant variability that may arise.

Observing the recent financial sector turmoil in the US and Europe, the report said it has necessitated the need to reassess risks to the financial stability and resilience of financial institutions in the context of monetary policy tightening.

While Indian banks and non-banking financial intermediaries remain sound and resilient, it said they need to stress test for these new shocks.

Capital buffer and liquidity position, therefore, must be constantly reviewed and strengthened. In order to further enhance supervisory inputs, the report said an Advanced Supervisory Analytics Group (ASAG) has been set up.