On Tuesday i.e. 28th April, there was a huge fall in the shares of public sector banks. This decline has come after a decision of the banking regulator Reserve Bank of India (RBI). RBI has confirmed that it will implement the ‘Expected Credit Loss’ (ECL) framework from April 1, 2027. There was fear of this in banks for a long time. This deadline was a blow to the markets, which were expecting a more relaxed deadline, and it forced investors to sell their shares. After this decision, the biggest decline was seen in the shares of Bank of India and Bank of Baroda. Shares of both fell by 3 per cent. Canara Bank fell by 2 per cent, and the country’s largest bank, State Bank of India (SBI), fell by 1 per cent.
Net worth of banks may reduce
The scale of this loss can be huge for public sector banks (PSUs). According to Macquarie, the net worth of PSU banks is likely to decline by 5 percent to 10 percent at a time. The brokerage firm also said that credit cost for PSU banks may increase by 20 to 25 basis points. Macquarie described these new rules as beneficial only for those banks with a high share of home loans, while banks with a high share of loans outstanding for more than 30-90 days (especially in unsecured loans, microfinance and vehicle finance), and all public sector banks in general, may have to face the worst impact.
Earlier it was estimated
Not everyone is looking at this loss from the same perspective. In a report released after the draft rules were released in October, Moody’s described its impact as more limited. Moody’s analysts said that we expect these proposed rules to reduce the ‘tangible common equity’ of banks by 50-80 basis points. Since this will be implemented gradually over a period of four years, allowing banks to avoid a major reduction in capital on day one, more banks will manage this decline in capital ratio by being more careful in paying dividends.
Hopes dashed due to RBI decision
RBI’s decision to extend the ECL framework on Monday dashed hopes that banks would be given more lenient time to comply with the rules. This change will replace the existing ‘incurred-loss provisioning model’. Under the old model, banks would provision capital only when a loss actually occurred, whereas the new model adopts a ‘forward-looking’ approach, under which banks must build a capital buffer in advance based on expected credit losses.
What kind of changes will there be?
Under the new framework, banks will adopt a “staging framework” for asset classification. Under this, more provision will have to be made for stressed loans and ‘effective interest rate method’ will have to be used. The central bank said that the purpose of this major change is to bring strength, transparency and uniformity in the entire banking sector.
Most importantly, RBI has confirmed that it will retain the existing 90-day overdue rule for classifying non-performing assets (NPAs). This will provide at least some degree of continuity to lenders, even if the entire provisioning structure for them is changing. The changes in the new rules are expected to affect the capital adequacy ratio of banks. This will further accelerate boardroom discussions about dividend policy, capital planning and loan book composition as we move towards 2027.
