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News: The Reserve Bank of India issued 14 final directions on April 27 introducing new norms for recognising bad loans in banks.
About RBI’s New Norms for Recognizing Bad Loans
- Main change: The new RBI norms shift banks from the incurred loss model, which is based on past losses.
- Banks will now follow a forward-looking Expected Credit Loss (ECL) model that requires them to build buffers based on likely future losses.
- Key Highlights of New RBI Norms:
- Three-Stage Approach: Loss allowance will follow three stages based on changes in credit risk since initial recognition.
- Stage 1: Financial instruments where there is no significant increase in credit risk, and banks will use a 12-month Probability of Default for loss estimation.
- Stage 2: Financial instruments where there is a significant increase in credit risk since initial recognition, and banks will use a lifetime Probability of Default for loss estimation.
- Stage 3: Under this stage , instruments are seen as ‘credit impaired’ as at the reporting date, which means the loan is facing serious repayment problems.
- Implementation Timeline: The norms will come into effect from April 1, 2027.
- Retention of NPA Definition: A loan will still be treated as a non-performing asset if it remains unpaid for 90 days.
- Three-Stage Approach: Loss allowance will follow three stages based on changes in credit risk since initial recognition.
- Implications for Banks and Economy:
- Improved Risk Management: Banks will use data-driven models and future economic conditions, which will improve transparency and early stress recognition.
- Higher Initial Provisioning: Some banks may see a one-time increase in provisioning, but overall capital adequacy impact is expected to remain manageable.
- Operational Changes: Banks will require closer integration between finance and risk functions and investment in data systems and modelling capabilities.
