The framework is likely to discourage aggressive risk-taking and promote sustainable profitability
FinTech BizNews Service
Mumbai, 3 May 2026: CareEdge Ratings has come out with the latest update on the ECL Norms. Its report has been titled “Indian Banks Well Positioned to Implement ECL Norms.”
Synopsis
• The Reserve Bank of India (RBI) has notified the Commercial Banks – Asset Classification, Provisioning and Income Recognition Directions, 2026, with effect from April 01, 2027. These Directions represent a significant advancement in India’s prudential regulatory framework by mandating a transition to an Expected Credit Loss (ECL)–based provisioning regime, thereby aligning domestic banking practices with internationally accepted financial reporting standards and BASEL III norms. These Directions largely mirror the draft guidelines, incorporating limited modifications and clarifications on select operational aspects.
Under the revised framework, banks are required to undertake a comprehensive fair valuation of their entire
loan portfolio, including all outstanding advances, at the time of transition. RBI has further clarified that any
difference between the fair value of financial assets and their carrying amounts immediately prior to the
transition date shall be adjusted directly against opening retained earnings, rather than being routed through
the profit and loss account. This treatment is expected to mitigate earnings volatility and reduce market
uncertainty, while directly impacting banks’ net worth.
• The sector’s strong capital buffers further support this transition. As of September 30, 2025, Indian banks
reported a Capital Adequacy Ratio (CAR) of over 17% and a Common Equity Tier I (CET I) ratio exceeding
14.5%, providing sufficient headroom to absorb higher provisioning requirements. As per CareEdge Ratings’
estimate, the impact of shifting to ECL models would be ~60 to 70 bps on the sector's capital adequacy, which
the banks would be able to absorb easily over the 4-year period allowed by the regulations.
• Nevertheless, the increase in forward-looking provisions, particularly for Stage 2 assets, is expected to exert
some pressure on banks’ Return on Total Assets (ROTA) during the implementation phase.
Overview
In furtherance of its objective to enhance the resilience, transparency, and global comparability of the Indian
banking system, RBI has been undertaking a calibrated transition from the existing Income Recognition, Asset
Classification and Provisioning (IRACP) framework that followed provisioning based on the incurred loss approach
to a more forward-looking ECL based provisioning regime. This shift is intended to place Indian banks on par with
their global counterparts and align domestic prudential standards with internationally accepted financial reporting
and Basel III norms.
RBI released an initial discussion paper on ECL in January 2023 to solicit stakeholder feedback, following which an External Working Group was constituted to examine the operational, prudential, and implementation aspects of the proposed framework. Considering the recommendations of the Working Group, the RBI issued draft guidelines in October 2025 (refer to our analysis titled “ECL Implementation: Limited Impact on Banks’ Capital”), culminating in the notification of the final Directions in 2026.
The framework formally replaces the extant IRACP norms with an ECL-based provisioning approach and establishes a more anticipatory and risk-sensitive credit loss recognition mechanism. These Directions are applicable to Scheduled Commercial Banks (SCBs), except for Regional Rural Banks, Small Finance Banks, and Payment Banks, thereby covering a substantial portion of the Indian banking system while allowing differentiated institutions to continue under their existing regulatory regimes.
ECL Framework
Under the ECL framework, banks would use a general approach consisting of three functions - probability of default (PD), loss given default (LGD), and earnings at default (EAD) that conforms to the instructions and principles outlined in these Directions. Under the ECL norms, banks will be required to assess at each reporting date whether the credit risk on a financial instrument has changed significantly since initial recognition. If so, the bank is required to make a loss allowance, estimated based on lifetime expected credit losses. Banks will be required to use a general approach comprising three key functions - PD, LGD, and EAD that conforms to the instructions and principles outlined in these Directions. Banks' investments in subsidiaries, associates, and joint ventures have been kept outside the purview of ECL-based provisioning.
Initial Recognition and Subsequent Measurement
At the time of initial recognition, banks are required to classify their assets into 3 stages based on credit risk: Stage 1: Low Credit Risk; Stage 2: Significant Increase in Credit Risk (SICR); and Stage 3: Credit Impaired.
Determination of Significant Increase in Credit Risk (SICR)
Subsequently, at each reporting date, the bank must assess the credit risk on financial instruments for any significant increase in credit risk and would recognise the ECL accordingly. The criteria adopted for Significant Increase in Credit Risk (SICR) must be duly documented. Based on the staging, the applicability of PD for each of the three stages.
The final guidelines have dispensed with the mandatory requirement of placing accounts under Stage 2 before
upgrading to Stage 1 for six months, as proposed in the draft guidelines, after rectification of all irregularities.
Banks may upgrade accounts based on their assessment of the sustainability of the rectification of default/ stress
in the exposures. Further, in case of multiple exposures to a single borrower, in case of overdue, the classification
as Stage 2 shall be at the facility level, while Stage 3 classification shall be at the borrower level.
The final guidelines also exempt banks’ exposure to foreign sovereigns, foreign central banks, multilateral development organizations, Bank for International Settlements (BIS), and International Monetary Fund (IMF) which attract 0% risk weight for capital adequacy computation from SICR test along with SLR eligible investments, direct claims on central government and Exposures fully guaranteed by the central government and is not required to maintain Stage 1 ECL on these exposures.
Prudential Floors on ECL
While banks would be required to arrive at ECL provisioning estimates at Stages 1 and 2 based on their models,
the ECL shall be subject to the following product-wise prudential floors as a regulatory backstop, based on product
type. The proposed prudential floors under the draft guidelines for Stage 1 were similar to the minimum provisioning requirements under the IRACP norms, or higher, for certain riskier asset classes. While many product-wise floors remain consistent across both versions, the final directions introduce specific adjustments for some retail and government-related exposures.
The final guidelines have broadly aligned the definition and prudential floors for real estate exposures with Basel guidelines.
The final guidelines have also kept the Stage 3 prudential floor in line with the draft guidelines, but provide some relief for certain types of exposures, such as claims secured by residential and commercial real and exposures backed by central government guarantees.
Regulatory Probability of Default (PD) and Loss Given Default (LGD)
For ECL computation, banks are required to have a minimum regulatory floor for 12-month PD. The final guidelines have reduced the regulatory PD from 0.05% to 0.03%. Banks shall calculate their own LGD using historical data and macroeconomic projections. If the bank cannot obtain LGD estimates from its data, it may use regulatory backstops. While keeping the regulatory LGD at a similar level, the final guidelines have reduced the LGD on loans secured by eligible collateral from 45% to 30% to align with the Basel guidelines.
Regulatory Backstop for computation of Earnings at Default (EAD)
Banks are required to estimate EAD appropriately for the purpose of computing ECL. For loan commitments and guarantee contracts, banks shall estimate the expected drawdown at default for EAD. Credit risk mitigants shall not be netted off for ECL. If EAD cannot be reliably estimated internally, banks may apply the regulatory credit conversion factors (CCF) under the Commercial Banks - Capital Charge for Credit Risk – Standardised Approach Directions, 2026.
CareEdge View
Sanjay Agarwal, Senior Director, CareEdge Ratings, said, “Overall, the transition to the Expected Credit Loss (ECL) framework represents a structurally positive development for the Indian banking system, reinforcing transparency, risk sensitivity, and alignment with global prudential standards. The guidelines come at a time when Indian banks have robust capitalisation levels and good asset quality. While the near-term impact of the transition is likely to differ across banks, public sector banks may face greater pressure owing to their higher exposure to unsecured and MSME segments and comparatively lower management overlays. In contrast, private-sector banks, which largely maintain conservative provisioning policies and contingent buffers, are expected to experience a more muted adjustment. Nevertheless, the sector as a whole enters this transition from a position of strength, supported by robust capital buffers and high provision coverage ratios, particularly for non-performing (Stage 3) assets.”
Aditya Acharekar, Associate Director, CareEdge Ratings, said,
“The clarifications provided in the final Directions—particularly with respect to prudential floors and the accounting treatment of transition adjustments—are expected to materially reduce uncertainty and smoothen market expectations. From an earnings perspective, incremental provisioning—especially for Stage 2 assets—is likely to elevate credit costs in the initial years, notwithstanding the regulatory allowance to add back excess ECL provisions to CET I capital. The new regime may also influence strategic behaviour, particularly during periods of net interest margin compression. Under ECL norms, any shift toward higher-yielding but riskier assets could attract disproportionately higher provisions, potentially offsetting margin gains and compressing returns on total assets. As a result, the framework is likely to discourage aggressive risk-taking and promote sustainable profitability.”
In summary, despite transitional challenges, the adoption of ECL-based provisioning is expected to structurally strengthen the resilience and credibility of the Indian banking system. Given strong capitalisation levels and the regulatory glide path, the overall sector outlook remains stable, with the transition anticipated to be earnings- absorbing and value-accretive over the long term.
