A paradigm shift is about to take place in banking, come FY28. Banks will move to an expected credit loss (ECL) model of providing for bad loans from the current incurred loss model. The ECL model is adopted globally, and it is the turn of banks in India to follow suit. Simply put, the model is inherently more proactive in recognising credit risk and by virtue of the RBI’s regulations, raises the baseline provision coverage significantly.
While this will certainly affect banks, it will also influence your borrowing costs — especially if you don’t closely monitor and maintain a good credit score.
What is the ECL model? What does it entail? How does it have implications on your credit score? We’ll dive into all of this, while also helping readers who are new to credit scores get started on the right foot.
Credit scores, or as some call them CIBIL scores, are three-digit numbers between 300 and 900 that measure an individual’s creditworthiness. Higher the score, higher the creditworthiness. In other words, higher the score, lower the borrowing cost. Here’s why.
You see, banks and NBFCs are in the risk business. Their objective is to maximise risk-adjusted returns or make the most money possible for a given level of credit risk (risk that the money lent may not be repaid in full or partially). A higher credit score implies a lower probability of default and so, banks may charge you a lower rate of interest . On the other hand, banks charge higher interest rates for borrowers with lower credit scores, simply because the risk is higher there.
One can segregate the spectrum of credit scores from 300 to 900 into four broad buckets. A score of 750 and above is the top tier and borrowers with such scores get the best deals. Data from CIBIL reveals that 79 per cent of all loans are sanctioned to persons with scores more than 750. Scores from 650 to 749 follow the top tier with rates offered being slightly higher. Scores 500-649 and 300-499 form the bottom most tiers. While rates will be certainly higher and terms less favourable, chances are high that your application will be straight up rejected.
Credit scores are provided by institutions known as CICs or credit information companies. These are licensed by the RBI to collect banking data of individuals for the calculation of credit scores. TransUnion CIBIL is the most popular CIC with its ‘CIBIL score’. Other CICs include Equifax, Experian and CRIF High Mark.
CICs track multiple financial parameters of an individual to arrive at the credit score but they broadly fit into one of the following – loan enquiries made, loans outstanding, repayment history and credit card history..
With that brief out of the way, let us address the elephant in the room. Starting FY28, banks will shift to the ECL model of making provisions on bad loans. But first, let us look at how things stand currently. As said above, banks follow an incurred loss model now. This model stipulates making provisions on an ex-post basis — meaning, provisions will be made only after the occurrence of a trigger event. Default or non-repayment of dues being the trigger here. However, the model suffers from a flaw. Defaults are just outcomes of credit risk which may be brewing for quite a while. By the time provisions are made, it becomes too late, unless banks themselves are voluntarily proactive.
A quick sidenote: Extant regulations do require banks to provide for standard assets (loans yet to become NPA) too but the quantum is not significant compared with the upcoming ECL framework (we will circle back to this later).
Let’s look at an example. Assume Swati has two personal loans - one from Bank A and the other from Bank B. Due to financial difficulties, she defaults on the loan from Bank A but manages to pay dues on the loan from Bank B. Under the current model, as Swati’s account hasn’t become NPA, Bank B need not create provisions (apart from the baseline provision on standard assets). However, it could only be a matter of time before she defaults on her dues to Bank B.
The ECL model fixes this very flaw. It would require banks to allocate higher provisions whenever there is an event that raises the probability of default risk and not wait until the actual default happens (ex-ante model). This in technical terms is defined as significant increase in credit risk or SICR, and forms the cornerstone of the ECL model.
In the above example, under ECL norms, Bank B would be required to recognise Swati’s account to be exhibiting SICR, taking cues from a dip in her credit score.
Provisioning under the ECL model follows a tiered approach. Accounts need to be classified into stages 1, 2 and 3, depending on whether they exhibit any SICR. Higher the stage, higher the provision. Before proceeding to the stages, it helps understanding what could cause SICR. The RBI’s Directions contain an illustrative list of drivers of SICR. Key among them are as follows: Changes in credit rating, macroeconomic environment of the borrower, the value of the collateral and any breach of contract that could result in covenant revisions.
Stage 1 accounts are those which have not seen any SICR since the beginning. As a baseline, banks need to make provisions on these accounts too, even though there is no default. Provisions need to be based on the next 12-month ECL — meaning, banks will have to look at all possibilities of default over the next 12 months, assign probability weights and appropriately make provisions. Banks can build models based on historical data to make these calculations.
Stage 2 accounts are those which have experienced SICR, but are yet to become Stage 3. Banks need to make provisions based on lifetime ECL — meaning, banks will have to look at all possibilities of default until the end of life of the loan, assign probability weights and create provisions. Assume a credit card holder’s credit score drops suddenly. If in the bank’s judgment, the account has seen SICR now, it should downgrade the account to Stage 2.
The RBI Directions also suggest that any account that is 30 days past due are to be classified as Stage 2, unless banks can prove otherwise that the account has not seen any SICR.
Stage 3 accounts are those which are considered to be ‘credit impaired’. Non-performing assets (NPAs) or accounts that are overdue by over 90 days fall under this category. Just like Stage 2 accounts, provisions are to be based on lifetime ECL. While the classification criterion is in line with extant regulations, the new framework additionally includes cases where a borrower is in financial distress or where there is a high probability of insolvency as ‘credit impaired’, even before becoming overdue by over 90 days.
While primarily, the quantum of provision is left to the judgment of the banks based on their models, the RBI has prescribed regulatory floors or minimum mandatory level of provisions. In general, the regulatory floor applicable for Stage 1 accounts is 0.4 per cent of loan outstanding, though for some loan products, a lower/ higher ratio has been prescribed. This is largely in line with the extant regulations for standard assets (accounts that are yet to become NPAs).
However, Stage 2 is where things get interesting. The general regulatory floor applicable for Stage 2 accounts is 5 per cent of loan outstanding, significantly higher than the 0.4 per cent prescribed by extant rules. Similarly, there is a bump in the general floor applicable for Stage 3 accounts (equivalent to sub-standard assets or NPAs under extant rules) to 25 per cent of loan outstanding from the 15 per cent per extant norms.
As you would have observed, under the upcoming ECL norms, banks may have to set aside substantially higher provisions, especially for Stage 2 and Stage 3 accounts — and all that differentiates a Stage 1 account from a Stage 2 (and perhaps further to Stage 3) is SICR, which could be due to a simple credit rating/ credit score downgrade. If banks are required to have higher provisions, their ability to put capital to the fullest use is hindered, thus logically leading to higher interest rates for accounts exhibiting SICR or rejection of application in some cases.
This, here, is the core idea of the story — why with ECL norms, you must be more careful about your credit score now than ever. Even inadvertent drops in the score could mean adverse consequences.
CICs look at four broad factors to compute your credit score. If you score well on these fronts, you can pretty much be assured of a good credit score.
Age of credit: How long your credit track record is. The longer the better. This is why you should think twice before closing one of those old, not-in-use credit cards you might have.
Payment history: How consistently you have paid your EMIs on time.
Credit utilisation: How much of the sanctioned credit you are actually using. This is particularly relevant for credit card users. Utilisation ratio of up to 30 per cent is considered healthy. Besides, it is advisable to have a mix of secured and unsecured loans. Too many unsecured loans or credit cards could take your credit score down.
Credit enquiries: How frequently you apply for loans in a given period of time. Too frequent enquiries could portray you as a credit-hungry person, affecting your score.
Having a weak credit score and hence high borrowing rates is one thing, having no credit history at all and therefore high borrowing rates is another. People falling under the latter category are referred to as ‘new to credit’ or NTCs. These are persons who wouldn’t have borrowed from a bank or NBFC in their lifetime and won’t have credit scores. When they eventually apply for a loan, banks might have no idea about their financial hygiene (which the credit score captures) and might end up charging them more. Here’s an example. Bank of India charges 7.1 per cent for a housing loan applicant with a credit score of 840 and above, while it charges 7.9 per cent for an NTC applicant. This is equivalent to the rate offered for an applicant with a score between 725 and 759 (see table).
As said above, building a good credit score takes time and lenders prefer a longer credit history. So, if you have plans to take a loan in the future, a housing loan, for instance, it is a good idea to get a credit card, preferably one secured by a fixed deposit, to start building your credit score. If you do so, ensure you pay the entire bill amount (not just the minimum due) on time. You can also choose a card that offers good reward points (to offset annual charges perhaps) or a co-branded card depending on your lifestyle.
Sometimes, it could so happen that due to circumstances, one may be pushed deep into debt due to layoffs, irrecoverable business losses, among others. Credit score in such cases could have taken a beating. In such cases, following these steps can help.
* Be consistent with paying EMIs on time to the maximum extent possible.
* Pay off loans one after another. If you have many credit cards and personal loan accounts, consolidate them and take a single loan. It will help you do away with multiple due dates.
* Convert some unsecured loans into secured loans like jewel loans, if possible. Reducing excess exposure to unsecured borrowings can help boost your credit score.
* Work towards reducing your existing EMIs to 30 per cent or lower of monthly income.
* Think twice before applying for additional credit.
* Monitor your credit report/ score every six months. You can do it for free on CIC websites. Inadvertent inaccuracies (EMI paid not reflected, for instance) may prevent you from improving your score.
* Rebuilding the credit score will take time. Prepare mentally.
It is important to regularly monitor the accuracy of your credit data in your credit report. The credit report contains your score, personal information, information on your monthly income and occupation. More importantly, it has details on the loans you have borrowed, loans you have applied for (’credit enquiries’), credit limit sanctioned, loans overdue and a record of your repayments, among others. It is your responsibility to ensure the accuracy of data contained in the report. Inconsistencies with actual records can be detrimental to your credit score. For instance, a loan repaid in full could still be reflected as being outstanding. Also look at the enquiries section. It may have details on loans you might not have applied for. CICs generally allow one free download of credit report per year. It is important to note that checking your own credit score often does not affect it.
Sometimes, the inconsistencies may be due to a time gap — between the actual transaction and when it is reflected in the report. If the difference is not automatically reconciled over time, raise a dispute with the CIC (you will need to sign up on their website). Attach supporting documents if necessary. You will get a response within 30 days, typically. Also give a heads up to the relevant bank/ NBFC for a smooth resolution. In extreme cases, escalate the issue on RBI Ombudsman platform.
Published on June 13, 2026
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