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The Reserve Bank of India has released a detailed Discussion Paper outlining a proposed shift from the current incurred loss model of loan loss provisioning to an expected loss–based approach for banks. This move, first announced in the Statement on Developmental and Regulatory Policies on September 30, 2022, aims to strengthen the credit risk management framework and align Indian banking practices with global standards such as IFRS 9 and Basel guidelines.
The Discussion Paper examines the operational, regulatory, and supervisory considerations involved in transitioning to an expected loss framework. It proposes principle-based guidelines supported by regulatory safeguards to ensure consistency and robustness. Regional rural banks and smaller cooperative banks are likely to be excluded from the new framework based on thresholds that will be finalised after stakeholder feedback.
Under the proposed system, banks will classify financial assets—primarily loans, irrevocable loan commitments, and certain categories of investments—into three stages based on credit risk assessments at initial recognition and at each reporting date. These stages will determine the level of provisions required. Banks will be permitted to design their own expected credit loss models, subject to broad guidance from the RBI. This guidance will outline key considerations for credit risk assessment, drawing from international standards.
To address model risk and potential variability in provisioning outcomes, the RBI has suggested several safeguards. These include independent validation of models, periodic back-testing, adherence to regulatory expectations, and application of a prudential floor on provisions based on comprehensive data analysis. Banks will also be required to make detailed disclosures once the framework comes into effect.
Recognising the time and expertise required to develop and test these models, the RBI plans to provide sufficient implementation time after issuing the final guidelines. Banks may also phase in the impact on their Common Equity Tier I capital over a period of up to five years to ensure a smooth transition.
The Discussion Paper seeks public feedback on key issues and invites comments with supporting analysis and evidence. Submissions may be sent by February 28, 2023, to the Chief General Manager, Credit Risk Group, Department of Regulation, Reserve Bank of India, Mumbai, or via email under the subject line specified in the paper.
[RBI]