RBI Proposes Draft Directions to Implement Expected Credit Loss and Basel III Rules
SDG 9: Industry, Innovation and Infrastructure | SDG 16: Peace, Justice and Strong Institutions
Institutions: Reserve Bank of India (RBI) | Ministry of Finance
The RBI has released draft directions to overhaul how banks manage risk and allocate capital, implementing key global Basel III reforms. The most significant shift is forcing commercial banks and All India Financial Institutions to adopt the Expected Credit Loss (ECL) framework for provisioning, replacing the old system where losses were accounted for only after they occurred. The ECL system mandates setting aside money based on a forward-looking estimate of potential future losses, significantly enhancing credit risk management. To smooth this transition, the RBI proposes a 5-year glide-path. Furthermore, the new rules adjust capital calculations to be more nuanced, providing favorable risk weight treatment for loans to priority sectors like MSMEs and for ‘transactors’—credit card users with a strong repayment history.
This report is central to India’s Financial Sector Reforms, ensuring the country’s banking standards meet international Basel norms, enhancing stability while structuring incentives for priority sector lending like to MSMEs.
What is the Expected Credit Loss (ECL) Model? The ECL model is a forward-looking accounting standard (Ind AS 109) that requires financial institutions to provision for potential losses the moment a loan is granted, based on expected future economic conditions, rather than waiting for a loss event to occur. It matters as it promotes prudential lending and strengthens a bank’s ability to absorb future credit shocks.
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RBI Draft Directions on Capital Charge and ECL