The Reserve Bank of India’s (RBI) recent circulars outlining a new framework for Expected Credit Loss (ECL) provisioning and modifications to risk weights are designed to ensure a smooth transition for the banking sector, avoiding any sudden capital shocks, according to top industry experts. Harsh Vardhan, Senior Advisor at Bain and Company, and Anil Gupta, Senior Vice President and Co-Group Head for Financial Sector Ratings at ICRA, both stated that the central bank’s calibrated approach provides a multi-year glide path for implementation, balancing prudential strengthening with financial stability.The new ECL norms, which are set to become effective from 2027-28 (FY28), represent a “paradigm shift” rather than an incremental change, Harsh Vardhan explained. “It’s a very fundamental change, and I think the RBI is doing it the right way because if you do it in a jerky manner, then there would be a capital shock,” he said.The five-year transition period is intended to spread the impact on bank capital and earnings, ensuring a smoother adjustment for lenders. Harsh Vardhan added that while the earnings impact will vary across institutions based on their existing standard asset provisions, the overall effect on the banking sector is expected to be “somewhat muted.”
From a ratings perspective, Gupta highlighted that the circulars contained “no negative surprises.” A key concern had been the level of the regulatory floor for provisions on Stage 1, 2, and 3 assets, but he found these to be at “comfortable” levels. “For example, the Stage 1 floor has been kept at maybe 0.25% to 0.4% for most of the retail loans and maybe secured loans. So that is something which is a positive,” he said. Similarly, he described the Stage 2 provisioning requirement of 5%, or 1.5% for home loans, as “fine” and not prohibitively high.Also Read: RBI’s ECL, Basel III norms positive for banking sector, says SBI chairman CS SettyHowever, Harsh Vardhan offered a nuanced view, suggesting the Stage 1 floors are “a bit lower than what I would have expected,” as they align closely with current standard asset provisioning levels. He speculated that these floors might be increased over time as more data becomes available and the system stabilises, viewing the current low level as part of the RBI’s strategy to provide a gentle introduction to the new regime.
Complementing the ECL framework, the RBI has also tweaked risk weights, a move seen as beneficial for banks. The changes are particularly favourable for corporate lending, where the risk weight for a ‘BBB’ rated loan has been reduced from 100% to 75%. Given that a large portion of the Indian banking portfolio falls into this category, Harsh Vardhan believes this could potentially lower the cost of credit for a significant number of companies if banks pass on the benefit of the lower capital requirement. The new rules also widen the definition of micro, small and medium enterprises (MSMEs) that can be treated under the retail category, extending it to firms with revenues up to ₹500 crore.Experts stated that the interplay between the two circulars. The positive capital impact from lower risk weights could help offset the negative impact from higher ECL provisions. Gupta explained that banks have two primary strategies ahead of the April 1, 2027, implementation date: they can either create floating or contingent provisions in the coming years, which would affect credit costs but smooth the transition, or build up their capital base to absorb a one-time knock on their net worth. He anticipates that many banks will opt to build provisions gradually, utilising their strong profit and loss statements.A particularly noteworthy development is the increased regulatory oversight of credit rating agencies. Gupta stated that the new framework links risk weights directly to the historical default rates of the rating agencies themselves. “If a rating agency has higher default rates, then the next category of the risk weight applies, or a higher risk weight applies,” he explained, calling it a “really interesting move.” This introduces a new layer of accountability, effectively rating the raters.Also Read: Former RBI officials urge caution as central bank eases banking rulesHarsh Vardhan added that this is part of a broader push for greater governance, including standardisation of default definitions and enhanced disclosure requirements, for both banks and rating agencies.For the entire interview, watch the accompanying videoCatch all the latest updates from the stock market here
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