Regulatory updates

At present, commercial banks in India, determine the provision for loan losses on the basis of an ‘incurred loss’ approach prescribed in the Prudential norms on Income Recognition, Asset Classification, and Provisioning pertaining to Advances issued by the Reserve Bank of India (RBI). However, it was observed that the incurred loss approach results in delay in recognition of the expected loss on financial assets due to which banks are required to make higher levels of provisions thereby affecting the resilience of banks and poses systemic risks.

In this regard, on 16 January 2023, RBI issued a Discussion Paper on Expected Loss (EL) based approach for loan loss provisioning by banks which recommends that banks adopt an Expected Credit Loss (ECL) approach for loan loss provision. The discussion paper is applicable to all scheduled commercial banks other than small co-operative banks²⁶The threshold for determining a ‘small’ co-operative bank would be prescribed by RBI based on comments received by it. and regional rural banks.

While the discussion paper advocates the impairment loss approach as prescribed in Ind AS 109, Financial Instruments, there are certain differences between the RBI’s proposed framework for loan loss provision (RBIs framework) and Ind AS 109. This model would be supplemented by a prudential floor as a regulatory backstop.

The comments on the discussion paper can be provided till 28 February 2023. Based on the comments received, the draft guidelines and subsequently, the final guidelines will be formulated. Further, as designing of the models would be a complex activity and significant time would be required to test them, RBI plans to provide sufficient time for implementation of the framework after issue of the final guidelines.

To access the discussion paper, please click here

Securitisation involves the process of pooling loans and selling them to a Special Purpose Entity (SPE), which in turn issues securities backed by the loan pool.

However, currently there is no such mechanism for the securitization of Non-Performing Assets (NPAs) through the SPE route. The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI or the Act) provides guidance for the securitisation of NPAs, but these have to be undertaken by the Asset Reconstruction Companies (ARCs) licensed under the Act. Based on the feedback received from various stakeholders, RBI decided to enable the securitisation of NPAs as well, through the SPE route. This was followed by the RBI announcement dated 30 September 2022, wherein it stated that a Discussion Paper would be issued soon, specifying the relevant provisions of the Securitization of Stressed Assets Framework (SSAF).

In this regard, on 25 January 2023, RBI has released the Discussion Paper on SSAF (the DP). Key aspects of the proposed framework include:

• Definition of ‘stressed assets’ eligible for securitisation under SSAF,
• Assets eligible for SSAF,
• Requirement of Minimum Risk Retention (MRR),
• Regulatory framework with respect to SPE, resolution manager and other stakeholders,
• Access of finance to resolution manager,
• Capital treatment,
• Due diligence requirements,
• Credit enhancement, and
• Valuation of securitisation notes under SSAF.

The DP is open for comments up to 28 February 2023.

To access the text of the DP, please click here