RBI proposes expected loss-based approach for provisioning of banks

Presently, banks are required to make loan loss provisions based on an ‘incurred loss’ approach, which used to be the standard globally till recently.

“To further enhance the resilience of the banking system, Reserve Bank proposes to amend the prudential regulations governing loan loss provisioning by banks to incorporate the more forward looking expected credit losses approach as against the extant ‘incurred loss’ approach,” the RBI said in the discussion paper on expected loss (EL)-based approach for loan loss provisioning by banks.

The impact of adopting the forward looking expected credit loss approach to estimating loss provisions, is likely to result in excess provisions as compared to shortfall in provisions.

The key requirement under the proposed framework shall be for the banks to classify financial assets (primarily loans, including 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, at the time of initial recognition as well as on each subsequent reporting date and make necessary provisions.