Banks may incur higher costs in the short term in the transition to RBI’s new framework on calculating provisions for bad loans, according to experts. 

RBI introduced the expected credit loss (ECL) as a method to calculate the provisioning requirement of banks to account for losses. If the credit risk for a loan has increased significantly, the loss-allowance would be calculated on lifetime ECL and for no increase in credit risk, allowance shall be recognised on 12-month ECL, RBI directed, adding that the new norms kick in from April 2027. Further, NPAs would be classified into three stages. The first stage is considered low or no credit risk where 12-month ECL is recognised and the other two are some and high credit risk, where lifetime ECL is recognised for provisions.

“This was a much awaited change and comes in line with the IFRS -9 framework, which was introduced globally in 2008. This is akin to a forward looking model to determine the repayability of a loan from the time it is originated,” said Satyadarshi Kunal, Partner at CMS INDUSLAW. He however said that the immediate impact would be a slight increase in cost if transitioning to the new method, and this may have to be transferred to the borrower. 

The new method, which mandates taking into account the expected credit loss to calculate provisions, is expected to hit the bank’s common equity tier-1 by a net of 120 basis points in the short run, according to a statement by rating agency CRISIL. 

The overall increase in costs and provisions may also have a one time hit on bank’s profit after tax but it is expected to be manageable, said Jatin Kalra , partner at Grant Thornton Bharat. “Banks which have a higher proportion of microfinance and unsecured retail lending would have greater impact,

The NPA classification is now borrower level and not account level according to the new rules, which means one bad loan for a customer , all of his or her loans would be considered NPA. The duration of non-repayment of a loan and NPA continues to be 90 days overdue. Moreover, once a customer is considered an NPA, he or she will have to repay all the liabilities to be upgraded back to standard assets. This will increase credit discipline of customers and does not likely to have any direct impact on the customer. 

The regulation comes at a time when the net NPA ratio is less than 1% for most major banks, signifying among the best asset quality standards for a bank.