ECL BASED PROVISIONING

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Context

• The Reserve Bank of India (RBI) is preparing for a major change in the banking system and will implement expected credit loss (ECL) on banks soon.

Details

• After the implementation of the rules related to ECL, banks will have to inform the RBI of their estimated loan losses in advance.
• In such a situation, loan provisioning of banks will increase and profit books may be affected. However, the banks have asked for some more time to transit on ECL and are also seeking time from RBI for this.

What is ECL?

• ECL is a method of accounting for credit risk based on the loss likely to occur on a loan or portfolio of loans.
• It is used to get an understanding of the potential future losses on financial assets and how those losses can be identified and addressed in the financial statements.
• Thus, through ECL, banks can estimate the forward-looking probability of default for each loan, and then by multiplying that probability by the likely loss given default, the bank gets the percentage loss that is expected to occur if the borrower defaults.
• The resulting value multiplied by the likely exposure at default is the expected loss for each loan, and the sum of these values is the expected loss for the entire portfolio.

Deadline to implement ECL

• RBI has given banks a deadline of June 30, 2023, to implement ECL.
• More time has been demanded from the banks as banks sought more time to raise capital.
• ECL provisioning will also be unlocked in some sectors. The burden of applying ECL will not fall on the customers.
• Banks will just have to make provisioning based on estimated losses.