The Reserve Bank of India wants to replace its decades-old, incurred-loss provisioning system with an Expected Credit Loss framework, reshaping how banks allocate capital and report financial health. The move, due to be implemented in April 2027, will align the country with global standards such as the UK’s International Financial Reporting Standard 9 and the US Current Expected Credit Loss model. But experts say the reform goes deeper, marking a cultural change from reactive loss recognition to proactive risk anticipation.
From incurred loss to expected loss
Under the current regime, which follows Basel III, Indian banks provision for bad loans only after defaults emerge. This amplifies distress during downturns.
The ECL model requires lenders to estimate potential losses over the life of a loan using historical data, borrower behaviour and macroeconomic forecasts.
Professor R. Narayanaswamy, chair of the RBI’s working group on the ECL framework, calls the change a “philosophical correction”.
“After 2008, policymakers realised accounting should not amplify crises. The incurred-loss model made good times look better and bad times far worse. ECL, in principle, forces restraint — but only if bankers and auditors act with integrity.
‘ECL is not about numbers — it’s about moral discipline. It forces management to confront risk before it becomes loss.’
— R. Narayanaswamy, RBI
The shift to ECL could also reshape how global investors read Indian banks’ balance sheets.
“Investors are willing to make adjustments, but comparing banks under different models is a big hurdle,” says the IASB member. “If India adopts ECL, it will be greeted enthusiastically by external investors — it makes the accounting comparable across jurisdictions and increases capital flow.”
A new rule book
The framework will apply to all large ‘scheduled commercial banks’, excluding regional rural banks, small finance banks and payments banks. The RBI says the shift will have a minimal impact on capital, with banks expected to remain comfortably above regulatory requirements. India’s capital adequacy norms require commercial banks to maintain a capital to risk-weighted assets ratio of at least 9 per cent — one percentage point higher than the Basel III minimum of 8 per cent.
A three-stage model is proposed, requiring lenders to estimate credit losses using probability of default, loss given default and exposure at default. Loans showing a significant increase in credit risk — typically when payments are more than 30 days past due — would attract lifetime provisioning instead of a year-long status. This contrasts with the current regime, where loans unpaid for up to 90 days can still be classified as ‘standard assets’, delaying recognition of stress.
The technical core
A former senior Indian central banker tells The Banker: “It’s a combination of global alignment and a deeper shift in how the RBI wants banks to think about credit risk. “Implementation will depend on institutional strength — and, most importantly, the willingness to embrace risk management.” Whether ECL is a success rests on reliable data and robust modelling — areas where banks’ readiness remains uneven.
‘Independent validation teams, proper documentation, and internal ownership are essential. The RBI will want banks to show that model predictions align with actual outcomes.’
— Arindam Bandyopadhyay
But Arindam Bandyopadhyay, banking risk expert and former faculty at the National Institute of Bank Management, says banks already have a wealth of available data.
“For corporate portfolios, they have at least a decade of borrower-level data to estimate ‘probability of default’,” he says. “For retail pools, non-performing asset data can be used to model PDs across personal, housing, SMEs and micro, small and medium-sized enterprise loan portfolios.”
Bandyopadhyay adds that the RBI’s prudential LGD floors — 65 per cent for secured loans and 70 per cent for unsecured — will ensure smoother migration and more countercyclical provisioning. “Model validation is critical,” he adds. “Independent validation teams, proper documentation, and internal ownership — even with vendor models — are essential. The RBI will want banks to show that model predictions align with actual outcomes.”
Smaller banks, bigger challenge
A chief compliance officer with experience at a globally systemic bank in the country warns that smaller lenders may not be fully prepared. “Small finance banks have evolved at very different speeds [when it comes to] sophistication, automation and data architecture,” says the CCO, who now works for a smaller lender. “Their core business remains small-ticket microfinance lending. While credit histories have improved, these portfolios are still highly vulnerable to shocks like demonetisation or Covid — the kind of risks no model can fully capture.”
ECL frameworks can be tailored to such portfolios, the officer adds. But the real challenge lies in data quality and asset realisation. “Most exposures are unsecured or only partly backed — unless expected losses are realistic, provisioning and pricing will remain flawed.” Banks with legacy technology stacks could also struggle, warns Sandip Khetan, co-founder and global head of Accounting & Reporting Consulting. The challenge for them will be to meet the draft’s data and validation demands.
“Regulators should enforce standardised stress tests and peer-level disclosures to expose hidden fragilities,” he says. Institutions with stronger analytics and thicker capital buffers will gain a structural edge. “First movers will have greater capacity to expand where others are constrained,” Khetan says. “Late adopters with weak data may need to curb growth or dividends until their metrics stabilise.”
‘Regulators should enforce standardised stress tests and peer-level disclosures to expose hidden fragilities.’
— Sandip Khetan, Accounting & Reporting Consulting
Lessons from early movers
Non-banking financial companies have followed the ECL framework since March 2020, when they adopted the Indian Accounting Standards regime.
Their experience offers an early view of what banks can expect.
“ECL is not merely a regulatory requirement; it represents a complete shift in mindset,” says Mohit Mairal, a senior risk professional with a non-banking financial company.
“At first, it increased provisioning pressure. Over time, it has driven disciplined underwriting and fostered a more stable credit environment.”
Banks with legacy technology stacks will struggle to meet the draft’s data and validation demands.
Sagar Lakhani, a partner at Accounting & Reporting Consulting, says banks with legacy technology stacks will struggle to meet the draft’s data and validation demands.
“Regulators should enforce standardised stress tests and peer-level disclosures to expose hidden fragilities,” he says.
Source: The Banker
