Credit risk

Credit Risk Assessment – The Hindu BusinessLine

In a recent statement, a Deputy Governor of the Reserve Bank of India said that the central bank is considering requiring banks to switch to the Expected Credit Loss (ECL) model for loan loss provisioning instead of the model. of incurred credit loss (ICL) currently in progress. followed.

The ECL model is one of the requirements of Ind AS (Indian Accounting Standards) that banks have yet to adopt. If banks adopt the ECL impairment framework, they will be required to recognize ECL at any time, taking into account past events, current conditions and forward-looking information, and update the amount of ECL recognized at each date. closing to reflect changes in the credit of an asset. risk.

Looking to the future

ECL is a forward-looking approach and will result in faster recognition of credit losses – the amount of losses recognized should also be higher. As a next step, the RBI should publish a discussion paper on this. As early as 2015, the RBI had set up a working group to discuss the impact of Ind AS on provisioning. The group’s main recommendation was that the prudential standards issued by the RBI should be the bare minimum that banks should expect. If banks believe that provisioning above prudential standards is necessary, they can fall back on the ECL model.

Since nothing significant has changed between 2015 and today with regard to the accounting standard on financial instruments, it is expected that the working document follows the recommendations of the working group. The implementation of Ind AS would impact the core financial statements of any bank or financial institution – the provisioning for loan losses and accounting for most of their cash transactions at fair value. Globally, banks have implemented ECL models considering forward-looking economic scenarios and their probabilities, customer risk ratings (CRRs), probability of default, and recoverability of impaired wholesale exposures . Modeling methodologies are developed from historical experience, which may limit their reliability for correctly estimating ECLs. These are often handled with adjustments, which are inherently based on judgment and subject to estimation uncertainty.

Covid-19 has impacted economic factors such as GDP and unemployment, and consequently the extent and timing of customer defaults. These factors have increased the uncertainty surrounding judgments made in determining the severity and likelihood of forecasts of macroeconomic variables used in ECL models.

Management has made significant adjustments to ECLs to address these limitations through “management overrides,” which are mathematical estimates. The determination of CRRs is based on quantitative dashboards, with qualitative adjustments for relevant factors.

The RBI did not mandate the banks to switch to Ind AS as changes had to be made to the Banking Regulation Act (including the format of Ind AS financial statements). Additionally, the RBI wanted to give banks some time to build up their balance sheets so that they are prepared for the impact of Ind AS.

However, the pandemic derailed all plans, forcing the RBI to announce moratoriums and restructuring plans. Instead of pushing Ind AS on banks and financial institutions in tranches, the RBI should order an outright transition to Ind AS. Banks will suffer some impact on the transition, but it can’t be worse than it has been for smaller listed companies. The impact of Ind AS could also accelerate consolidation in the banking sector.

The author is a chartered accountant

Published on

June 23, 2022