Indian Banks Increase Provisions Ahead of New Expected Credit Loss Framework

Banks in India are increasingly making provisions in excess of immediate regulatory mandates, a trend re-emerging after the pandemic. This time, the impetus comes from a change in the risk framework for doubtful advances, specifically the implementation of the Expected Credit Loss (ECL) framework. This new framework involves a transition starting April 2027, with full compliance expected by FY31.

Several public sector banks, including Bank of Maharashtra, Indian Bank, and Uco Bank, have begun frontloading these provisions from the June quarter onwards. Indian Overseas Bank plans to follow suit from the next quarter. These banks are building up buffers to account for potential future credit losses more accurately. For instance, Indian Bank has set aside ₹400 crore for Special Mention Accounts (SMA 1) and plans to maintain a 5% provision as per draft ECL guidelines.

Initial estimates suggest a bank with a loan portfolio of ₹2.5-2.8 lakh crore might need an additional ₹2,500-2,800 crore in provisions at the transition point, though banks can spread this over three years until FY31. Some lenders are also planning to utilize unused Covid-related provisions to meet these requirements. Uco Bank, for example, has allocated ₹1,000 crore, including Covid provisions and new ECL provisions.

On the private sector side, IndusInd Bank reported a quarterly loss of ₹437 crore after making accelerated provisions of ₹900 crore and writing off ₹1,940 crore in microfinance loans, indicating stress in that segment. Federal Bank has also applied a management overlay on some standard accounts as a precaution. Jana Small Finance Bank has made ₹222 crore in accelerated provisions, primarily due to microfinance sector stress.

Impact: This proactive provisioning can reduce a bank's immediate reported profits but significantly strengthens its balance sheet, preparing it for future economic downturns or sector-specific stresses. This can be viewed positively by investors looking for long-term stability, although it might temper short-term earnings growth. The impact on the banking sector is moderate, with a rating of 6/10.

Difficult terms: Expected Credit Loss (ECL) framework: A new accounting standard that requires financial institutions to estimate and provision for expected credit losses over the lifetime of their loans, rather than just incurred losses. Frontloading provisions: Making provisions for future potential losses in the current accounting period, ahead of when they are strictly required. Special Mention Account (SMA) 1: A classification for loan accounts that show signs of stress, where principal or interest payment is overdue by 1 to 30 days. Management Overlay: An additional provision made by bank management based on their judgment and assessment of potential risks, which might go beyond the standard regulatory requirements. Microfinance Sector: The provision of financial services to low-income individuals and small businesses that traditionally lack access to banking and related services. Contingent provisions: Funds set aside to cover potential losses that are not certain but are possible based on certain future events. Floating provisions: Provisions held by banks to cover potential losses that are not yet identified with specific assets but are anticipated in the future, often due to general economic conditions. The ECL framework may mandate the phasing out or restructuring of these.