The Reserve Bank of India (RBI) on 16th January released the discussion paper on expected loss (EL)-based approach for loan loss provisioning by bank. It proposes to move to provisioning on the principles of ‘expected losses’ from ‘incurred losses.’
- A loan loss provision is something a bank creates to set aside funds for default or problem loans.
Key points
- It has proposed a framework for adoption of an ‘expected loss-based’ approach for provisioning by banks. The proposed norms are for all scheduled commercial banks, excluding regional rural banks.
- Presently, banks are required to make loan loss provisions based on an ‘incurred loss’ approach, which used to be the standard globally till recently.
- The objective is to further enhance the resilience of the banking system.
- Reserve Bank has proposed to amend the prudential regulations governing loan loss provisioning by banks to incorporate the more forward looking expected credit losses approach as against the extant ‘incurred loss’ approach.
- The key requirement under the proposed framework shall be for the banks to classify financial assets (primarily loans, including irrevocable loan commitments, and investments classified as held-to-maturity or available-for-sale) into one of the three categories: Stage 1, Stage 2, and Stage 3.
- The classification will depend on the assessed credit losses on them, at the time of initial recognition as well as on each subsequent reporting date and make necessary provisions.
- Banks will be allowed to design and implement their own models for measuring expected credit losses for the purpose of estimating loss provisions in line with the proposed principles.
