The RBI on Wednesday formed an external working group to seek independent inputs on how banks could make provisions on bad loans using an expected credit loss (ECL) method which represents a major shift from the current incurred loss-based provisioning regime.

The RBI released a discussion paper in January suggesting banks switch to the ECL method, in which lenders assess the probability of default upfront and provision accordingly, rather than after a default as is the current norm.

The discussion paper envisages a forward-looking, principle-based framework for provisioning for credit risk, which has already been implemented under the International Accounting Standards Board (IASB) and US Financial Accounting Standards Board (FASB), the RBI said.

It has been decided “to constitute a Working Group in order to get independent inputs on some of the technical aspects having a bearing on the significant transition involved,” the RBI said in a release. The newly constituted working group would be chaired by R. Narayanaswamy, former professor at IIM Bangalore, and will include domain experts from academia and industry as well as representatives from select banks, the RBI added.

Commenting on the announcement, Jaya Vaidhyanathan, CEO, BCT Digital feels its a positive move.

“The move to ECL provisioning would be a quantum leap from the current incurred-loss regime, and a much needed one, despite potential short-term impacts on bank profitability. We believe that the recommendations of the distinguished experts who are part of the working group, will alleviate some of these concerns and add immense value to the formulation of the draft guidelines,”

Ultimately, it is evident that aligning with the global standards set by IASB and US-FASB signifies our commitment as a country to adopt the best practices in the banking industry. We are excited about the potential this move holds for the future of finance in India, she added.