Additionally, upfront fair valuation may also deplete retained earnings

The new ECL framework marks a major regulatory shift for India’s banking sector; it has been long overdue, and therefore, there was no case that the RBI could have deferred it further; pleadings to defer the implementation were rejected by the regulator. It comes coupled with regulatory floors for provisions, which would cause a major increase in provisioning requirements over the earlier 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.

This is in addition to fair valuation requirement on upfront adoption, as on 1st April, 2027. While a vaguely worded part in para 19 was inserted on suggestions of the stakeholders, if interest rates have moved up since the date of the original loan, there will be almost a sure case of upfront valuation loss, which will eat up retained earnings.

RBI had come 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 final regulations were notified on 26th April and are applicable w.e.f 1.04.2027 i.e., for FY 27-28. The manner of implementation will be that all loans as on 1st April 2027 will be fair valued, and all new loans/financial instruments originated or acquired on or after 1st April 2027 will be subject to ECL provisions. See the highlights of the final regulations here.

A major impact that the 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 earlier framework, banks made provisions only after a loss has incurred, i.e., when loans actually turn non-performing. The newECL 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 a more granular comparison.

Type of asset	Asset classification	Existing requirement	New requirement w.e.f 1.04.2027	Difference
Farm Credit, Loan to Small and Micro Enterprises	SMA 0	0.25%	0.25%	–
	SMA 1	0.25%	5%	4.75%
	SMA 2	0.25%	5%	4.75%
	NPA	15%	25%-100% based on Vintage	10%-85% based on Vintage
Commercial real estate loans	SMA 0	1%	Construction Phase -1.25% Operational Phase – 1%	Construction Phase -0.25% Operational Phase – Nil
	SMA 1	1%	Construction Phase -1.8125% Operational Phase – 1.5625%	Construction Phase -0.8125% Operational Phase – 0.5625%
	SMA 2	1%	Construction Phase -1.8125% Operational Phase – 1.5625%	Construction Phase -0.8125% Operational Phase – 0.5625%
	NPA	15%	25%-100% based on Vintage	10%-85% based on Vintage
Secured retail loans, Corporate Loan, Loan to Medium Enterprises	SMA 0	0.4%	0.4%	–
	SMA 1	0.4%	5% (0.4% for loans against FD, NSC, LIC and KVP) (2.5% for direct exposures to/guaranteed by State Governments)	4.6% No change for loans against FD, NSC, LIC and KVP
	SMA 2	0.4%	5%(0.4% for loans against FD, NSC, LIC and KVP) (2.5% for direct exposures to/guaranteed by State Governments)	4.6% No change for loans against FD, NSC, LIC and KVP
	NPA	15%	25%-100% based on Vintage 10%-100% for loans against FD, NSC, LIC and KVP and for direct exposures to/guaranteed by State Government)	10%-85% based on Vintage
Exposures under various schemes of Credit Guarantee Fund Trust for Micro andSmall Enterprises (CGTMSE), Credit Risk Guarantee Fund Trust for Low IncomeHousing (CRGFTLIH) and National Credit Guarantee Trustee Company Ltd (NCGTC)	SMA 0	0.4%	0.25%	0.15%
	SMA 1	0.4%	0.25%	0.15%
	SMA 2	0.4%	0.25%	0.15%
	NPA	No provision for the guaranteed portion. NPA provisioning as per extant guidelines for the portion outstanding in excess of the guarantee (Only when the Governmentrepudiates its guarantee when invoked)	10%-100% based on vintage for secured and guaranteed portion 25%-100% based on vintage for unsecured and unguaranteed portion (Only if the claims are not settled with ninety datesfrom the due date of the loan)
Home Loans	SMA 0	0.25%	0.25%	0.15%
	SMA 1	0.25%	1.5%	1.25%
	SMA 2	0.25%	1.5%	1.25%
	NPA	15%	10%-100% based on Vintage	(-)5% – 85% based on Vintage
LAP	SMA 0	0.4%	0.4%	–
	SMA 1	0.4%	1.5%	1.1%
	SMA 2	0.4%	1.5%	1.1%
	NPA	15%	10%-100% based on Vintage	(-)5% – 85% based on Vintage
Unsecured Retail loan	SMA 0	0.4%	1%	0.6%
	SMA 1	0.4%	5%	4.6%
	SMA 2	0.4%	5%	4.6%
	NPA	25%	25%-100% based on Vintage	0%-75% based on Vintage

The actual impact of such additional provisioning will be a hit of more than 3% to the profit of banks. Based on the RBI Financial Stability Report of FY 24-25, 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.

Effective Interest Rate requirement applies to all loans effective 1st April, 2027

ECL does not come alone; it comes along with the Ind AS 109 companion – the requirement to compute effective interest rate (EIR) for all financial assets and financial instruments. How does EIR requirement differ from the existing rate of interest/internal rate of return approach? Because EIR has the impact of amortising loan acquisition costs or upfront fees. Currently, banks could have taken the upfront earnings such as processing or origination fees/costs directly to revenue – these will now have to part of the EIR computation. More than impacting the profit number, EIR creates a significant impact on loan management systems, as it results in dual computations – the accounting balances and the customer LMS balances are likely to be different.

Upfront recognition of fair value changes

Para 19 requires that on 1st April, 2027, that is, the date of first adoption, all financial assets and instruments will be fair valued, and the fair value changes (gains or losses) will be adjusted against retained earnings. This is consistent with the principles of first time adoption of Ind AS.

On stakeholder representation, the RBI added this part to Para 19:

Where facts and circumstances indicate that the transaction has been undertaken on terms such that the fair value of the financial asset is not materially different from its carrying cost, the same shall be presumed to be the best evidence of fair value.

What does this imply? If the terms of the financial facility have remained the same, does it mean no fair valuation has to be done? Surely no, at least in our opinion. Any fair value change in fixed rate instruments happens for two reasons: change in credit spreads (rating changes, credit quality changes, etc), or change in rate of interest. If there is a facility extended, say at a rate of interest of 8%, whereas the prevailing rate of interest for a borrower of similar credit standing has moved up to 10%, will there be a fair value decrease? Surely yes.

There are lots of loans which were extended during Covid or periods of low interest rates, which are still continuing. In all such cases, fair value losses are imminent.

The meaning of the para above can only be that if the terms of the original facility are similar to what they would currently be, then the fair value will not have to be computed.

See our other resources:

Factoring DLG into ECL: Relief, But Not A Free Pass

February 19, 2026/0 Comments/in Financial Services /by Team Finserv

Vinod Kothari & Chirag Agarwal | finserv@vinodkothari.com

RBI had earlier directed NBFCs to compute expected credit loss (ECL) without considering the impact of any default loss guarantees (DLGs) obtained from its lending service provider (LSP). We had published a short note explaining why this position was debatable (See our article on the topic here) and had also made a formal representation to RBI on the issue.

Back to the present, RBI has issued an amendment to the IRACP Directions, 2025 (dated February 13, 2026), permitting lenders to factor in DLG while determining provisions under the ECL framework across all stages.

Further, RBI has also specified that upon every event of invocation of DLG, the DLG cover reduces to the extent of invocation. Accordingly, REs shall recompute their ECL provisioning requirements across stages, after duly adjusting for the reduced DLG cover.

With these clarifications now in place, the next question that arises is: How should Regulated Entities (REs) appropriately factor DLG into their ECL computations? The article below discusses the above question at length.

How to factor in DLG in ECL computation?

Let us understand this in simple terms. Suppose a lender estimates that the expected loss on a loan pool is 3.8%. If the lender has received a guarantee of 5%, backed by fixed deposits that are lien-marked in its favour. The guarantee is sufficient to cover the expected loss. In such a case, effectively, the lender does not expect to bear any loss. On the other hand, if the expected loss is 6.8% and the guarantee covers only 5%, then the lender’s net expected loss would be the balance 1.8%.

However, this adjustment assumes that the guarantee will actually be honoured when required. A guarantee does not, however, eliminate risk completely; it merely shifts the risk of default or loss from the borrower to the guarantor, up to the guaranteed amount.

DLG & bankruptcy remoteness

The DLG guidelines specify the forms in which a DLG can be obtained. DLG can be accepted in any one of the following forms:

Cash deposited with the RE;
Fixed Deposit maintained with a Scheduled Commercial Bank with a lien marked in favour of the RE;
Bank Guarantee in favour of the RE

Accordingly, DLG can only be obtained in fully funded forms, thus eliminating any question of incurring credit loss on such a guarantee. Does that mean that even in case of insolvency of the DLG provider the lender will have the right to invoke the guarantee? The answer to this is negative. Because unlike in the case of bankruptcy-remote SPV, the guarantor is an operating entity, and is prone to the risk of insolvency.

In case of initiation of insolvency proceedings, all the assets of an insolvent entity form part of the insolvency administration/liquidation estate and are beyond the reach of the creditors. The proceeds from the realisation of assets are paid to the creditors in accordance with the waterfall mechanism as specified under section 53 of the IBC, 2016 .

Accordingly, it becomes important to determine how each permitted form of DLG would be treated in the event of insolvency of the DLG provider.

Cash deposited with RE: The cash deposited with the lender is actually a liability held in the books till the same is invoked. As per Section 36 of IBC 2016, assets that may or may not be in possession of the corporate debtor including but not limited to encumbered assets form part of the liquidation estate. Accordingly, cash deposited by the DLG provider with RE would form part of the liquidation estate of the guarantor.
Lien marked FD: Similar to cash deposited with RE, the lien marked FD will also form part of the liquidation estate.
Bank Guarantee: In the case of a bank guarantee, the credit exposure effectively shifts from the original guarantor to the issuing bank. Given that scheduled commercial banks are subject to stringent regulation and supervision, the risk of insolvency in banks is generally remote. Accordingly, the probability of default in such a structure is unlikely to be impacted.

So, even if the DLG is structured as a funded guarantee, the actual invocation can become complicated if the DLG provider goes into insolvency before such invocation. In such a situation, the lender may not be able to simply invoke the guarantee and take the money. Instead, it may have to submit its claim and wait for distribution under the insolvency process, where payments are made in the statutory priority order.

Under the waterfall mechanism, secured creditors rank alongside workmen’s dues. Now, in most DLG structures, the guarantor is a fintech entity or a co-lender. These entities typically do not have significant workmen-related liabilities. This may mean that the lender’s priority position is relatively stronger.

Further, the actual invocation process of the DLG should also be considered. For instance, cash held with the lender can be easily invoked and adjusted as compared to a lien-marked FD or bank guarantee, where there could be procedural delays.

Illustration: Consider a loan pool of ₹100 crore where the gross ECL rate is estimated at 6.8% (for the static pool covered by the guarantee), resulting in a gross ECL of ₹6.8 crore. The lender has a DLG cover of 5% of the pool (₹5 crore), structured as a lien-marked fixed deposit provided by a fintech sourcing partner. While the DLG is funded, there remains a risk that the guarantor may become insolvent. The first relevant question here is whether we will take a probability of default (PD) as per Stage 1 (12 months PD), or Stage 2/3 (lifelong PD). While the guarantor in question is not in default at all, however, given that the 6.8% ECL is a combination of Stage 1 as well as Stage 2/3 loans, in our view, the PD for the guarantor, to remain conservative, should be the lifelong PD over the tenure of the loans. Let us assume a 20% Probability of Default (PD) for the guarantor. Next question is assessment of Loss Given Default (LGD). As discussed above, the lender has the benefit of full security in form of lien on the fixed deposit, however, there may be depletion of the same on account of first priority in the waterfall, that is, costs of insolvency and bankruptcy process. On a conservative basis, we may, therefore, assume a 10% LGD. Thus, the expected loss on the DLG cover would therefore be 20% × 10% = 2%.

As a result, the ECL computation may now be:

= 5%*2% + 1.8% = 1.9%

Based on the aforesaid discussion, in our view, while the guarantee is funded the lender may have to adjust the probability of default to factor in the risk of insolvency, particularly where the guarantee is funded in the form of a cash deposit or a lien marked FD.

Which funded form of DLG is most suited?

As per the analysis, the various options of funded DLG can be ranked basis the maximum consideration allowable for ECL computation:

Bank guarantee: Being bankruptcy remote and easiest to invoke
Cash deposit: May have to consider the risk of guarantor’s bankruptcy but the invocation would be easier
Lien marked Fixed Deposit: May have to consider the risk of guarantor’s bankruptcy and invocation may involve procedural delays

However, given that there will not be a sizable or material difference in the quantum of counter guarantee risk, the selection of the options for ECL computation may not be significant.

Can we help this situation?

One of the ways to mitigate the risk of insolvency is by structuring the guarantee in such a way that the guarantee may be invoked upon the occurrence of an adverse material change in the financial condition of the guarantor. In other words, other than the occurrence of losses in the pool, if there are events of default such as adverse material change, insolvency of the guarantor etc., the lender may invoke the guarantee.

Early invocation upon identifiable stress on the part of the guarantor could help the lender realise the guarantee amount before the commencement of insolvency proceedings.

However, such clauses must be appropriately incorporated and drafted in the DLG agreement to ensure the following:

A clear definition of “adverse material change”
Identifiable trigger events
Clarity on invocation mechanism

Impact of DLG invocation on ECL computation

RBI has also provided a clarification that upon every event of invocation of DLG, the DLG cover reduces to the extent of invocation. Accordingly, REs would be required to recompute their ECL provisioning requirements across stages, after duly adjusting for the reduced DLG cover.

Pool-based guarantees presuppose that the pool is static. This is purely intuitive because if the pool is dynamic, new loans will continue to enter the pool, and therefore, the guarantor’s exposure will keep spreading over a continuing flow of new loans.

Where the pool is static, the loans gradually get repaid (amortised) over time. As borrowers repay their instalments, the outstanding amount of the loan pool keeps reducing. Since the exposure is shrinking, the ECL on that pool will also typically reduce over time, assuming normal performance. Therefore, whether the utilisation of the DLG on account of pool defaults may cause the ECL computation to increase? This may be so for 2 reasons: one, usual terms of DLG invocation will be the full amount of the defaulted loan will be recovered (due to escalation of the entire principal outstanding). Thus, while the performing loans amortise over time, the non-performing loans are fully recovered once they reach “default”, causing the utilisation of the DLG to run faster than the amortization of the performing loans. Second reason is that once the pool actually starts defaulting, there may be a reason to provide higher estimates of probability of default as well.

Integral part of the contractual terms: Is DLG required to form part of the loan agreement?

Para 36A of the IRAC Directions read with the principles under Ind AS 109 provides that credit enhancements may be considered while computing ECL only where such enhancements are “integral to the contractual terms.” The expression “integral to the contractual terms” is taken from the definition of “credit loss” in Ind AS 109. Credit losses are measured after considering the expected cashflows from an asset. Those cashflows will factor in the recovery of any collateral, or credit enhancements, as long as the said credit enhancement is integral to the contractual terms.

What exactly is the meaning of “integral to the contractual terms”? Are we expecting the guarantee (DLG in the present case) to be a part of the terms of the loan contract? That would never be the case, as the so-called guarantee (which may legally be regarded as an indemnity contract) is a bilateral contract between the lender and the DLG provider. Neither is the borrower aware of the guarantee, nor is it desirable to have the borrower know of the guarantee, for obvious reasons.

IFRS 9 uses the same language. US ASC has more elaborate discussion on this. Para 326-20-30-12 says:

The estimate of expected credit losses shall reflect how credit enhancements (other than those that are freestanding contracts) mitigate expected credit losses on financial assets, including consideration of the financial condition of the guarantor, the willingness of the guarantor to pay, and/or whether any subordinated interests are expected to be capable of absorbing credit losses on any underlying financial assets. However, when estimating expected credit losses, an entity shall not combine a financial asset with a separate freestanding contract that serves to mitigate credit loss. As a result, the estimate of expected credit losses on a financial asset (or group of financial assets) shall not be offset by a freestanding contract (for example, a purchased credit-default swap) that may mitigate expected credit losses on the financial asset (or group of financial assets)

There has been a significant discussion on whether the benefit of a guarantee or credit enhancement which is not a part of the contractual terms of the loan can be factored in ECL computation. From discussions before the IASB, as back as in 2018, two conditions for recognising the benefit of credit enhancements were discussed:

part of the contractual terms; and
not recognised separately by the entity.

The second condition is easy to understand. For example, if the risk of default is hedged by a credit default swap, the value of the same, amounting to a derivative, is separately recognised. Hence, the question of factoring the same while computing ECL does not arise. However, the first condition, relating to contractual terms of the asset, still remains vague.

One may try to get some clues in the US FASB discussions, where para 326-20-30-12 has been interpreted in technical interpretations. In addition, there is a definition of “freestanding contracts” under the Glossary of ASC 326:

A freestanding contract is entered into either:

a. Separate and apart from any of the entity’s other financial instruments or equity transactions

b. In conjunction with some other transaction and is legally detachable and separately exercisable.

The “forming integral part of the contractual terms” does not warrant the principal contract to provide for the guarantee or the credit enhancements. Insisting on the same will be counter-intuitive, except in case of trilateral contracts. However, the conditions indicate that the guarantee or credit enhancement integrates and becomes an inseparable part of the underlying loan or group of loans. For example, if the group of loans was to be transferred, is it such that the benefit of the guarantee may stay iwth the originator and loans may be transferred, or the guarantee travels along with the loans? If the latter is the case, there is no doubt that in reality, the guarantee has become an embedded part of the loan transaction.

Another factor may be the contractual association between the loan cashflows and the payout from the credit enhancements. Some relevant considerations:

Is the guarantee specific to the contractual cashflows from the loans?
Does the guarantor pay what the original loan asset would have paid, or pays independent of the contractual cashflows?
If the lender subsequently recovers the cashflows from the asset, is the payout from the guarantee restored back to the guarantor?

The presence of these factors will suggest the integration or embedding of the guarantee into the contractual cashflows from the loans.

Conclusion

While the recent amendment by the RBI brings welcome clarity by allowing DLG to be factored into ECL computation, lenders must approach this carefully and realistically. A DLG can reduce the expected loss, but it does not make the risk disappear, as the DLG provider itself faces the risk of insolvency. The form of the guarantee, its enforceability, and the possibility of invocation- all of these matter in assessing the true level of protection. REs should not treat DLG as a mechanical deduction from ECL, but as a risk mitigant that requires thoughtful evaluation, continuous monitoring, and recalibration as the pool amortises and the cover reduces.

See our other resources:

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

October 9, 2025/0 Comments/in Banks, Financial Services, Indian Accounting Standards (Ind AS), RBI, Uncategorized /by Staff

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.

Type of asset	Asset classification	Existing requirement	Proposed requirement	Difference
Farm Credit, Loan to Small and Micro Enterprises	SMA 0	0.25%	0.25%	–
	SMA 1	0.25%	5%	4.75%
	SMA 2	0.25%	5%	4.75%
	NPA	15%	25%-100% based on Vintage	10%-85% based on Vintage
Commercial real estate loans	SMA 0	1%	Construction Phase -1.25% Operational Phase – 1%	Construction Phase -0.25% Operational Phase – Nil
	SMA 1	1%	Construction Phase -1.8125% Operational Phase – 1.5625%	Construction Phase -0.8125% Operational Phase – 0.5625%
	SMA 2	1%	Construction Phase -1.8125% Operational Phase – 1.5625%	Construction Phase -0.8125% Operational Phase – 0.5625%
	NPA	15%	25%-100% based on Vintage	10%-85% based on Vintage
Secured retail loans, Corporate Loan, Loan to Medium Enterprises	SMA 0	0.4%	0.4%	–
	SMA 1	0.4%	5%	4.6%
	SMA 2	0.4%	5%	4.6%
	NPA	15%	25%-100% based on Vintage	10%-85% based on Vintage
Home Loans	SMA 0	0.25%	0.40%	0.15%
	SMA 1	0.25%	1.5%	1.25%
	SMA 2	0.25%	1.5%	1.25%
	NPA	15%	10%-100% based on Vintage	(-)5% – 85% based on Vintage
LAP	SMA 0	0.4%	0.4%	–
	SMA 1	0.4%	1.5%	1.1%
	SMA 2	0.4%	1.5%	1.1%
	NPA	15%	10%-100% based on Vintage	(-)5% – 85% based on Vintage
Unsecured Retail loan	SMA 0	0.4%	1%	0.6%
	SMA 1	0.4%	5%	4.6%
	SMA 2	0.4%	5%	4.6%
	NPA	25%	25%-100% based on Vintage	0%-75% based on Vintage

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

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/ )
↩︎
Based on our rough estimate of the data available here: https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=1300 ↩︎

ECL Framework for Banks: Key Highlights

October 8, 2025/0 Comments/in Accounting and Taxation, Banks, Banks, Financial Services, Indian Accounting Standards (Ind AS), RBI /by Staff

-Team Finserv (finserv@vinodkothari.com)

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RBI Monetary Policy Update: Enhancing Financial Stability for Banks and NBFCs

October 1, 2025/0 Comments/in Financial Services /by Team Finserv

– Team Finserv | finserv@vinodkothari.com

Introduction

As a part of the governor’s statement dated October 1, 2025, it was highlighted that banks and NBFCs continue to exhibit financial stability, by way of strong liquidity positions, capital adequacy, and sustained profitability. Further, NBFCs have shown improvement with better asset quality and declining GNPA ratios. Against this backdrop, the RBI has maintained a cautious yet forward-looking stance, keeping policy rates unchanged while focusing on strengthening financial stability, enhancing risk management, and reinforcing consumer protection through regulatory measures affecting banks and NBFCs. Some of the developmental and regulatory policy measures introduced by the RBI, which are expected to impact financial entities such as banks and NBFCs, have been discussed below:

Key Highlights:

Particular	Change and Impact
Expected Credit Loss (ECL) Framework	Applicability: Banks Impact/Change: RBI plans to implement an ECL-based provisioning framework for banks, effective from April 2027.Under this framework, banks will be required to make provisions upfront for potential losses based on expected credit deterioration, in alignment with that being followed by NBFCs under IndAS.The ECL approach is intended to strengthen credit risk management and promote more forward-looking provisioning practices.You can read our analysis on the same here.
Basel III Guidelines – Standardised Approach	Applicability: Scheduled Commercial Bank, excluding Small Finance Banks, Payments Banks, and Regional Rural Banks Impact/Change: RBI has proposed draft guidelines on the Revised Basel Framework – Standardised Approach for Credit Risk. Accordingly, the approach for arriving at risk weight for computation of capital ratios will be revisited. While guidelines are awaited, IIRB approach may be introduced for Indian Banks, in line with global practices. Guidelines are awaited.
Risk-Based Premium Framework for Deposit Insurance	Applicability: All Commercial Banks, All State, Central and Primary Cooperative Banks Impact/Change: At present, the Deposit Insurance and Credit Guarantee Corporation (DICGC) operates the deposit insurance scheme where each depositor in a bank is insured up to a maximum of ₹5,00,000. Currently, DIGC levies a uniform flat premium of 12 paise per ₹100 of deposits from all banks, irrespective of the financial strength of the bank. The RBI has now proposed a shift to a Risk-Based Premium Framework, which would reduce the premium payable by banks that are financially sound. Guidelines are awaited.
Risk Weights on Infrastructure Lending by NBFCs	Applicability: NBFCs engaged in project finance, HFCs with LAP exposure, and banks with large infrastructure portfolios Impact/Change: “Infrastructure lending” (as per para 5.1.14, SBR Master Directions) refers to credit extended by way of term loans, project loans, or investment in bonds/debentures/preference/equity shares of a project company, where the subscription is treated as an advance or other long-term funded facility in the sub-sectors as may be notified by the Ministry of Finance. Under SBR, provisioning norms did not differentiate between construction and operational phases, overlooking the higher risks during construction. The Project Finance Directions, 2025 addressed this by mandating higher provisioning for under-construction projects. Presently, NBFCs can apply lower risk weights to operational PPP projects (50% for operating vs. 100% for construction). RBI now proposes a principle-based framework to better align risk weights with the actual risk profile of operational projects. Guidelines are awaited.
Review of the External Commercial Borrowing Framework	Applicability: Entities intending to avail an External Commercial Borrowing. Impact/Change: RBI has proposed a review of the External Commercial Borrowing (ECB) framework to rationalise and simplify existing regulations. The proposed changes include Expanding eligible borrower and lender categories, Relaxing borrowing limits and maturity restrictions, Removing cost ceilings, Revising end-use conditions, Simplifying reporting requirements. Draft regulations are yet to be issued for the same.
Strengthening the Internal Ombudsman (IO) Mechanism	Applicability: NBFCs-NDs with an asset size of ₹5000 crore and above, and having public customer interface; Deposit-taking NBFCs with 10 or more branches. Impact/Change: The RBI intends to enhance the effectiveness of the IO framework introduced for the REs in 2018 (revised direction was introduced in 2023). As per the extant regulatory requirements, the IO serves as an independent authority within the applicable REs to review complaints that are rejected by the REs. The proposed revisions seek to strengthen this mechanism by: Empowering IOs with compensation powers and granting them the ability to directly interact with complainants, thereby aligning their role more closely with that of the RBI Ombudsman. Introducing a two-tier grievance redress structure within applicable REs, to ensure that complaints are first addressed at multiple levels internally before being escalated to the IO. The draft of the revised master direction on the internal ombudsman is yet to be released, which will then be open for wider analysis of the changes and their implication.
Review of Reserve Bank – Integrated Ombudsman Scheme, 2012	Applicability: The Scheme applies to services rendered by Regulated Entities in India to their customers under the RBI Act, 1934; Banking Regulation Act, 1949; Payment and Settlement Systems Act, 2007; and the Credit Information Companies (Regulation) Act, 2005. Impact/Change: The RBI has conducted a comprehensive review of the RBI – Integrated Ombudsman Scheme, and will be releasing the draft of the revised Scheme for stakeholder feedback. The revision of the scheme is related to the following: To extend its applicability to State Co-operative Banks and District Central Cooperative Banks (previously under NABARD), thereby the customers of these rural co-operative banks can now approach the RBI Ombudsman for complaints related to banking services instead of NABARD. To enhance clarity, simplify procedures and reduce timelines to ensure more effective handling of complaints. Considering the publications, there is expectation of cross reporting between RBI Ombudsman and Internal Ombudsman.
Consolidation of Regulatory Instructions	RBI is streamlining and consolidating its regulatory instructions into Master Directions for easier access and compliance. Around 250 draft Master Directions, covering 30 regulatory areas across 11 types of regulated entities, will be published on the RBI website, and stakeholders will be given an opportunity to review them and give feedback on their completeness and accuracy.

Should you expect adjustment in profits for “Expected Credit Loss”?

July 5, 2025/0 Comments/in Companies Act 2013, Corporate Laws, Indian Accounting Standards (Ind AS), LODR /by Staff

– Customised profits for CSR and managerial remuneration under Section 198 of the CA, 2013

– Pammy Jaiswal and Sourish Kundu | corplaw@vinodkothari.com

Background

The presentation of the profit and loss account has been outlined under the Schedule III of the Companies Act, 2013 (‘Act’) and the profit computation method has been provided for under the applicable accounting standards [See IND AS 1]. The basic principle is to showcase a true and fair view of the financial position of a company. Having said that, it is also significant to mention that the Act provides for an alternative method for computing net profits, the basic intent of which is to arrive at an adjusted net profit which does not have elements of unrealised gains or losses, capital gains or losses and in fact any item which is extraordinary in its very nature. The same is contained under the provisions of section 198 of the Act. This section, unlike the general computation method, has a limited objective i.e., calculation of net profits for managerial remuneration as well as corporate social responsibility.

There are four operating sub-sections under section 198 which provides for the adjustment items:

Allowing the credit of certain items – usual income in the form of govt subsidies
Disallowing the credit given to certain items – unrealised gains, capital profits, etc.
Allowing the debit of certain items – usual working charges, interests, depreciation, etc
Disallowing the debit of certain items – capital losses, unrealised losses, usual income tax, etc

It is important to note that items other than those mentioned above need not be specifically adjusted unless their nature calls for adjustment under the said section. Now if we discuss specifically for items in the nature of Expected Credit Loss (‘ECL’) for companies following IND AS, it is important to understand the nature of ECL in the context of making adjustments under section 198 of the Act. See our write on Expected Credit Losses on Loans: Guide for NBFCs.

Understanding ECL and Its Accounting Treatment

Reference shall be drawn from Ind AS 109 which defines ‘credit loss’ as ‘the difference between all contractual cash flows that are due to an entity in accordance with the contract and all the cash flows that the entity expects to receive (i.e. cash shortfalls), including cash flows from the sale of collateral held.’ ECL is essentially a way of estimating future credit losses, even on loans that appear to be fully performing at the time of such analysis (Stage 1 assets). It is based on expected delays or defaults, and the estimated loss is recorded as a charge to the profit and loss account, based on a 12-month probability of default.

As per Ind AS 109, ECL is used for the recognition and measurement of impairment on financial assets both at the time of origination as well as at the end of every reporting period. ECL is a forward-looking approach that requires entities to recognize credit losses based on the probability of future defaults/ delays.

However, this does not result in a reduction in the carrying value of the asset (unless the asset is already credit-impaired, i.e., Stage 3). In that sense, while ECL reflects asset impairment, it does not operate like a direct write-down. And unlike conventional provisioning, ECL is not a “provision” under traditional accounting – it is a loss allowance rooted in forward-looking estimations. Further, it is also important to understand that the booking of ECL does not mean that there has been a credit loss in the actual sense, the same is a methodical manner of estimating the probable default risk association with the asset value.

Treatment of ECL under Section 198

Section 198 requires excluding unrealised or notional adjustments, such as fair value changes or revaluation impacts in terms of Section 198(3) of theAct.

The section also refers specifically to actual bad debts, under Section 198(4)(o). This raises the natural interpretational question: should model-driven, probability-weighted ECL charges – which do not reflect realised losses – really be allowed to remain deducted while computing such customised profits? Well, the answer lies in the requirement and nature of such an item being required to be deducted from the profit and loss account under IND AS 109.

Alternative approaches -Treatment of ECL

The question around the treatment of ECL can be viewed from two perspectives. The first being the nature of ECL and the second on the routine treatment and calculation of ECL. If we look at the nature, it is clear that while it is imperative for companies to compute ECL at the time of origination as well as at the end of every reporting period, it is important to note that there is no loss or default in the actual sense. This means that the amount computed as ECL has not been an actual default.

On the other hand, if we look at the need for such computation and the methodical approach to arrive at the value of ECL, the same is likely to be considered as a usual working charge which is charged to the profit and loss account. Accordingly, we have come across two possible and permissible approaches to the treatment of ECL while computing the profits under section 198. The same has been discussed below with the help of illustrations.

Approach 1: Disallowing ECL in the year of its booking and subsequent adjustment of bad debt

Year 1	Year 2
PBT – 1000 Depreciation – 20 ECL – 40 Loss on sale of fixed asset – 15	PBT – 1200 Depreciation – 20 ECL – 35 Actual Bad Debt – 15 Profit on sale of equity shares – 25

Year 1	Amount	Year 2	Amount
PBT	1000	PBT	1200
Depreciation	–	Depreciation	–
Add: ECL	40	Add: ECL	35
Add: Loss on sale of fixed asset	15	Less: Profit on sale of equity shares	(25)
PBT u/s 198	1055	PBT u/s 198	1210

Notes:

ECL has been ignored in profit computation u/s 198 considering the same is an unrealised loss and therefore reversed.
Depreciation and actual bad debt has not been adjusted again as it has already been deducted under normal profit computation.
Capital gains and losses have been adjusted/ reversed under the computation.

Approach 2: Allowing ECL in profit computation and netting off actual bad debt from the same in subsequent period

Year 1	Year 2
PBT – 1000 Depreciation – 20 ECL – 40 Loss on sale of fixed asset – 15	PBT – 1200 Depreciation – 20 ECL recovered – 35 Actual Bad Debt – 15 Profit on sale of equity shares – 25

Year 1	Amount	Year 2	Amount
PBT	1000	PBT	1200
Depreciation	–	Depreciation	–
ECL	–	ECL	–
Add: Loss on sale of fixed asset	15	Actual bad debt	–
		ECL recovered	–
		Less: Profit on sale of equity shares	(25)
PBT u/s 198	1015	PBT u/s 198	1185

Notes:

ECL has been considered in profit computation u/s 198 and therefore, not adjusted to reverse the impact
Similarly, ECL recovered has been considered part of normal or routine adjustment and hence, not reversed.
Actual bad debt is not to be considered at the time of profit computation under the regular computation since it can be adjusted from the ECL already booked.
Capital gains and losses have been adjusted/ reversed under the computation.

Concluding remarks

All listed companies are required to comply with Ind AS and given that an instance of a company having nil receivables is a rare occurrence, the discussion on how ECL is to be treated while computing net profit in terms of Section 198 becomes more than just an academic debate.

As long as the impact of any P&L item being extra ordinary in nature is taken off from the profits computed u/s 198, the same serves the purpose and intent of section 198 of the Act. ECL, while valid for accounting, is fundamentally an estimated, non-actual loss. It exists because accounting standards demand alignment of income with credit risk and not because a real outflow has occurred. However, it cannot be said that ECL already deducted while calculating profit before tax as per applicable accounting standards will be reversed while calculating profits in terms of Section 198.

Further, given that ECL is based on expectation calculated using due accounting principles, the actual bed debt, if within the ECL limit, does not impact the P&L. On the contrary, in case of the actual bad debt being in excess, the P&L warrants a subsequent debit of the net amount. For example, under approach 2 if the actual bad debt would have been 50, i.e. in excess of the ECL booked in the previous period by 10, the normal profit computation would have allowed a debit of 10.

In fact, both the approaches lead to the fulfilment of the intent of section 198 and hence, it is not necessary to consider any one approach as correct. Having said that, it is imperative to follow uniform practice in this regard in the absence of which the profits u/s 198 may be impacted.

Therefore, where the statutory and accounting frameworks intersect – but are not necessarily aligned – companies must adopt a carefully considered, principle-based approach as even a single line item like ECL can materially influence the base for managerial remuneration and CSR spending unlike other estimate based items such as revenue deferrals viz. sales returns or warranties, which are made as a matter of accounting prudence, but does not represent outflows for statutory computation purposes. Accordingly, there is no reason for deviating from the Indian GAAP principles for the purpose of customised calculation of net profits for specific purposes.

Read more:

Cash in Hand, But Still a Loss?

Impact of restructuring on ECL computation

Knowledge Centre for Corporate Social Responsibility (CSR)

Cash in Hand, But Still a Loss?

May 30, 2025/0 Comments/in Financial Services, NBFCs, RBI /by Staff

RBI mails to NBFCs to disregard DLG in expected loss computation

– Vinod Kothari & Dayita Kanodia (finserv@vinodkothari.com)

Background

RBI has recently been directing NBFCs to compute ECL without factoring in the impact of DLGs obtained¹. This stance appears to stem from the regulator’s perception that fintech-issued guarantees carry inherent risk and may expose NBFCs to potential losses.

As per Ind AS 109, Expected Credit Loss (ECL) model is used for the recognition and measurement of impairment on financial assets. ECL is a forward-looking approach that requires entities to recognize credit losses based on expectations of future defaults.

The Default Loss guarantee Guidelines (‘DLG Guidelines’) allow LSPs, (both regulated and unregulated) to provide DLG to the extent of 5% of the portfolio amount to the lender. The DLG Guidelines specify the forms in which such DLG can be obtained.

In terms of para 22 of the DL Guidelines,

“RE can accept DLG only in one or more of the following forms:

Cash deposited with the RE;
Fixed Deposit maintained with a Scheduled Commercial Bank with a lien marked in favour of the RE;
Bank Guarantee in favour of the RE”

Accordingly, DLGs can only be obtained in fully funded forms thus eliminating any question of incurring credit loss on such guarantee.

RBI Directive to NBFCs

RBI has directed NBFCs to maintain ECL without giving effect to the DLGs obtained in accordance with the DLG Guidelines. In this respect, the following should be taken into consideration:

A regulatory prescription, without a regulatory backing, and in fact, going against the regulation:
- There is a well-laid process for the RBI coming with a regulation, and in fact, now, the RBI has decided to come up with a consultation process, impact assessment etc before coming with a regulation.
- Dictating a certain treatment with respect to ECL is nothing short of a regulation – if this sort of generic requirements keep coming from the supervisors, then the very dividing line between supervision and regulation is lost.
Let accounting standards prevail; auditors and accountants know what ECL to provide:
- Annex II of the SBR Directions provides that NBFCs shall follow applicable accounting standards. The ECL provisioning, known as impairment loss, comes from para 5.5.13 of Ind AS 109. The detailed requirements of how ECL is to be estimated has been laid in that standard.
- Admittedly, whether and how much ECL write down is required, and whether such ECL estimation does or does not give effect to a fully-funded guarantee, is a matter for the accountants and auditors to deal with. We find little reason for the regulator to step into what is clearly an accounting standard domain.
If there is a funded guarantee, how can losses met by such guarantee be disregarded?
- As per DLG guidelines, the guarantee has to be either fully funded, or fully backed by bank guarantee. It is true that even if a credit loss is backed by a guarantee, it is merely shifting of the exposure – from the borrower to the guarantor. But in this case, the guarantee is equivalent to cash. If the lender has a cash collateral to back up the guarantee, there is no reason to not give the benefit of the same in ECL estimation.
- For example, if for a certain loan pool, the ECL estimation is 3.8%, and the lender has a guarantee of 5% backed by fixed deposits lien-marked to the lender, will the lender have any expected loss? The answer is negative. If the ECL estimation was, say, 6.8% and the guarantee is 5%, clearly the lender’s ECL will be 1.8%. Thus, there is no reason to disregard the funded guarantee while estimating ECL.
If a company cannot incur loss to the extent of the guarantee, and it still creates an impairment loss, it is actually creating a reserve and not a provision, and therefore, compromising its true and fair view:
- The RBI expects lenders to disregard the guarantee and create ECL as if the guarantee did not exist. This will be like creating a loss where the losses actually cannot hit the lender. Therefore, the ECL becomes a reserve, and given that the entity is hitting the P/L with a loss that will not hit the lender, the entity is compromising its true and fair view.
The RBI has reasons to have no trust on the fintechs for the guarantee they give, but it is fully funded.

In light of this, the RBI’s emails sent to various lenders are objectionable, and such emails create a precedent of creating a regulation without going through the regulatory process.

Accordingly, in our view, NBFCs should be allowed to follow their applicable accounting standards while computing the ECL provisions.

Our resources:

https://economictimes.indiatimes.com/industry/banking/finance/rbi-tightens-default-loss-guarantee-rule-nbfcs-to-exclude-cover-on-fintech-sourced-loans/articleshow/121420936.cms?from=mdr
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Demand and call loans: Economics and regulatory considerations

April 5, 2024/0 Comments/in Financial Services, RBI /by Vinod Kothari

Vinod Kothari | finserv@vinodkothari.com

From lenders’ perspective, demand and call loans seem to be as liquid as money in a bank fixed deposit, and yet an option to earn substantially higher interest rates. The practice of demand loans exists in the financial marketplace; at the same time, it is often commonplace in the case of intra-group loans. However, there are various risks, considerations and regulatory implications in case of such lending.

This article goes beyond Reg. 28 of the Scale Based Regulations of the RBI and discusses economics, policy issues, liquidity and credit risk considerations, both for the lender and the borrower, as well as issues like NPA treatment, expected credit losses, etc.

What is a demand/call loan?

The word “call money” is typically used in the banking sector for very short-term loans, which are callable at any time by the lender. Demand loan is a term usually associated with longer-term loans, though with no fixed repayment date, that is to say, the loan may be demanded back by the lender at any time. The following features of demand/call loans are discernible:

There is no fixed repayment date, but that does not mean there is no outer date for seeking repayment of the loan at all. For example, the terms of the loan may say – the lender may seek repayment of the loan at any time; however, if any earlier repayment is not demanded by the lender, the loan will be repaid on its 1st anniversary. Hence, there is an outer date, subject to the possibility of the lender demanding repayment at any time.
Given its nature, the loan is also puttable by the borrower, that is, repayable by the borrower at the borrower’s instance. It does not seem logical to impose a prepayment penalty for earlier voluntary repayment by the borrower.
Does the demand loan have to be repaid immediately upon demand? Except in the case of call loans which are very short-term loans by nature, a demand loan may provide a certain number of days after demand, for example, 14 days after demand is made by the lender.
Can the repayment of the loan be demanded by the lender partially? The answer seems to be affirmative; of course, the borrower may repay the whole of the loan.
The principal amount of the loan is payable on demand; how about the interest? The interest should still be serviced regularly. Reg 28.2 (iv) and (v) expect interest to be serviced monthly or quarterly, unless the sanctioning authority records a reason for not insisting on regular interest service.
In demand loans, liquidity evaluation is as equally as important as the credit evaluation of the borrower. This is quite obvious, because however strong the financial position of the borrower, if the borrower does not have access to ready sources of liquidity, he will not be able to pay on demand.

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