RBI proposes banks to design own credit loss models under newer provisioning system

Banks will be allowed to design own credit loss models and spread the higher provisions over a five-year period under a newer system of setting aside money for lending, the RBI proposed on Monday.

The Reserve Bank of India will issue “broad guidance” required to be considered while designing the credit risk models, the RBI said in the paper which is now open for public comments.

"Banks would be allowed to design and implement their own models for measuring expected credit losses for the purpose of estimating loss provisions in line with the proposed principles," the paper suggests.

At present, banks use the “incurred loss” model for loan provisioning, wherein banks are required to set aside money much later. In September last year, Governor Shaktikanta Das had announced that the regulator is mulling a shift to the newer system calling it as a “more prudent and forward looking approach”.

The discussion paper said banks will have to classify financial assets, including primarily loans, irrevocable loan commitments, and investments classified as held-to-maturity or available-for-sale, into one of the three categories - Stage 1, Stage 2, and Stage 3, depending upon the assessed credit losses on them.

It adds that the classification will have to be done at the time of initial recognition as well as on each subsequent reporting date, and banks will have to make necessary provisions.