Expected to bleed: ECL framework to cause ₹60,000 Cr. hole to Bank Profits

Dayita Kanodia and Chirag Agarwal | finserv@vinodkothari.com

The proposed ECL framework marks a major regulatory shift for India’s banking sector; it is long overdue, and therefore, there is no case that the RBI should have deferred it further. However, it comes coupled with regulatory floors for provisions, which would cause a major increase in provisioning requirements over the present requirements. Our assessment, on a very conservative basis, is that the first hit to Bank P/Ls will be at least Rs 60000 crores in the aggregate. 

RBI came up with a draft framework on ECL pursuant to the Statement on Developmental and Regulatory Policies, wherein it indicated its intention to replace the extant framework based on incurred loss with an ECL approach. The highlights can be accessed here.

A major impact that the draft directions will have on the Banking sector is the need to maintain increased provisioning pursuant to a shift from an incurred loss framework to the ECL framework. Under the existing framework, banks make provisions only after a loss has been incurred, i.e., when loans actually turn non-performing. The proposed ECL model, however, requires banks to anticipate potential credit losses and set aside provisions for such anticipated losses. 

Banks presently classify an asset as SMA1 when it hits 30 DPD, and SMA2 when it turns 60. Both these, however, are standard assets, which currently call for 0.4% provision. Under ECL norms, both these will be treated as Stage 2 assets, which calls for a lifetime probability of loss, with a regulatory floor of 5%. Thus, the differential provision here becomes 4.6%.

Once an asset turns NPA, the present regulatory requirement is a 15% provision; the ECL framework puts these assets under Stage 3, where the regulatory minimum provision, depending on the collateral and ageing, may range from 25% to 100%. Our Table below gives more granular comparison.

The actual impact of such additional provisioning will be a hit of more than 3% to the profit of banks¹. Based on the RBI Financial Stability Report of FY 24-25², the current level of SMA and NPA is estimated to be ₹3,78,000 crores (2%) and ₹4,28,000 crores (2.3%), respectively. 

Accordingly, an additional provision of approximately₹ 18,000 crores (4.6% of SMA volume) and ₹ 42,000 crores (10% of NPA volume) will be required for SMA and NPA respectively, leading to a total impact of at least ₹60,000 crores. This estimate has been arrived at by considering the % of NPAs and SMA-1 & SMA-2 portfolios of banks. The actual impact may be higher, as lot of loans may be unsecured, and may have ageing exceeding 1 year, in which case the differential provision may be higher.

It may be noted that while the draft directions allow Banks to add back the excess ECL provisioning to the CET 1 capital, it does not neutralize the immediate profitability impact, as the additional provisions would still flow through the profit and loss account.

How do we expect banks to smoothen this hit that may affect the FY 27-28 P/L statements? We hold the view that it will be prudent for banks, who have system capabilities, to estimate their ECL differential, and create an additional provision in FY 25-26, or do technical write-offs.

Other Resources

• Expected credit losses on loans: Guide for NBFCs
• Impact of restructuring on ECL computation
• Tattva Session 3 – RBI Provisions and Expected Credit Loss (ECL): Understanding their Interplay

1. The total Net profit of SCBs is ₹ 23.50 Lakh Crore for FY 24. (https://ddnews.gov.in/en/indian-scbs-post-record-net-profit-of-%E2%82%B923-50-lakh-crore-in-fy24-reduce-npas/ )
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2.  Based on our rough estimate of the data available here: https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=1300 ↩︎