RBI forms external working group on expected credit loss framework

The Reserve Bank of India (RBI) has taken a significant step by forming an external working group (WG) to address the expected credit loss (ECL) framework for loan loss provisioning. This initiative aims to gather independent insights into the intricacies of this substantial shift in the banking sector.

Leadership and Composition

• The WG will be led by R. Narayanaswamy, former Professor at IIM Bangalore.
• It consists of eight experts, with representation from six banks and one member each from KPMG and the Indian School of Business, Hyderabad.

Mandate of the Group

The primary objectives of this working group include:

• Defining Credit Risk Model Principles: The group will outline the principles that banks must adhere to when creating credit risk models for evaluating and quantifying expected credit losses.
• Addressing Credit Risk Elements: They will propose the elements that banks need to consider when determining credit risks, drawing from guidelines in IFRS 9 and principles established by the Basel Committee on Banking Supervision.
• Validation Methodology: The panel will advise on the methodology for independent external validation of these models to ensure their accuracy and reliability.
• Prudential Floors: Based on comprehensive data analysis, the group will propose prudential floors for provisioning, which will contribute to the overall stability of the banking sector.

Role in RBI Guidelines:

The recommendations of the WG will play a crucial role in shaping RBI’s guidelines for the ECL framework. These draft guidelines will undergo a public feedback process before their finalization.

Transition and Flexibility:

• While the shift to the ECL framework from the existing incurred loss provisioning system has not been scheduled, RBI has assured that banks will receive ample time to adapt once the final guidelines are issued.
• The discussion paper had previously mentioned that banks would have the flexibility to phase out the impact of increased provisions on Common Equity Tier I capital over a period of up to five years.

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