What is ECL?

The Expected Credit Loss (ECL) framework is a new rule from the Reserve Bank of India (RBI) for banks to handle bad loans better. It helps banks guess and set aside money for loans that might go wrong in the future.

RBI put out a draft of these rules on October 7, 2025. This changes the old way where banks only saved money after a loan actually became bad. It's like planning ahead instead of reacting later. The new system starts from April 1, 2027, and banks have five years to fully adjust.

Why Was It Brought? 

RBI brought this to make banks stronger and safer. The old system waited for losses to happen, which could surprise banks during bad times like economic slumps. ECL makes banks predict problems early using data and future outlooks. This matches global rules like IFRS 9, so Indian banks can be on par with world standards. It helps spot risks sooner, keep the banking system stable, and handle tough times better. After things like COVID, it's important to be ready for future issues.

IFRS 9, issued by the International Accounting Standards Board (IASB), is the international financial reporting standard that provides guidance for the accounting of financial instruments. It addresses the classification, measurement, and derecognition of financial assets and liabilities, as well as hedge accounting. 

How It Works?

1. Banks Check Loans Regularly: Every few months, banks look at each loan. They use data like the borrower's payment history, current money situation, and future guesses (like if the economy might slow down).
2. Three Stages for Loans:
   • Stage 1 (Good Loans): The loan is fine, and the borrower is paying on time. No big risks yet. Bank sets aside a small amount for possible losses in the next 12 months.
   • Stage 2 (Warning Signs): The loan is still okay, but risks are growing (e.g., borrower is late by 30+ days or facing money troubles). Bank sets aside money for possible losses over the whole life of the loan.
   • Stage 3 (Bad Loans): The loan is in big trouble (e.g., borrower hasn't paid for 90+ days or is bankrupt). Bank sets aside a lot of money, based on how much they might lose forever.
3. Calculating the Money to Set Aside:
   1. Banks use math formulas with three main things:
      • Chance of Default: How likely is the borrower to stop paying?
      • Loss if Default Happens: If they stop paying, how much money will the bank lose (after selling any collateral like a house)?
      • Amount at Risk: How much is still owed on the loan?
   2. Multiply these together to figure out the "expected loss" and save that amount.
4. Why This Way?
   • It's forward-looking: Banks prepare for bad times before they happen, like saving for a rainy day.
   • Matches global rules (like IFRS 9) so Indian banks are on the same level as others worldwide.
   • Helps avoid big shocks to the banking system.

• Banks can move loans back if they improve, but with rules like waiting periods. They must use good data and models, checked by outsiders.

Who It Applies To?

The Expected Credit Loss (ECL) Framework by the Reserve Bank of India (RBI) mainly applies to big and important banks in the country. It covers all Scheduled Commercial Banks and All-India Financial Institutions such as NABARD, SIDBI, EXIM Bank, and the National Housing Bank.

These are large institutions that play a major role in India’s financial system, so RBI wants them to follow international standards for better risk management. The rule also applies to some foreign banks that operate in India, like HSBC, Citi Bank, and Standard Chartered, so that they follow the same global standards as their parent companies. If a financial group’s main company (parent entity) comes under RBI’s control, then all its subsidiaries and joint ventures also have to follow the ECL rules.

However, some smaller banks are currently excluded from this rule. These include Small Finance Banks, which mostly operate in specific regions; Payments Banks like Paytm Payments Bank and India Post Payments Bank, which don’t give loans; and Regional Rural Banks (RRBs) that serve farmers and small businesses in rural areas.

RBI has temporarily left them out because many of these banks still lack advanced data systems and risk models. But in the future, as these smaller and rural banks upgrade their technology and capacity, RBI may bring them under the ECL framework in phases.

Impact on Banks?

The shift to ECL is expected to require higher upfront provisions, particularly for banks with larger unsecured or retail portfolios (e.g., personal loans, credit cards, microfinance). However, the overall effect on regulatory capital is projected to be minimal (e.g., up to 30 basis points reduction in capital adequacy ratios based on FY25 data), thanks to strong existing buffers (CET1 ratios often 2–8% above minimums) and the extended glide path. Banks like those with improved asset quality in recent years may see moderated impacts. RBI has invited stakeholder feedback on the draft until November 30, 2025, before finalizing.

Benefits of ECL

• Safer Banks: Spots problems early, so banks can fix them before they grow.
• Better for Economy: Helps during tough times by having money ready.
• Fair and Clear: All banks follow the same rules, making it easier to compare.
• Global Match: India joins other countries, which is good for international business.

Challenges 

• Banks need new systems, good data, and smart models to predict losses. This costs money and time.
• At first, they might have to set aside more money, which could lower profits.
• Small banks or those with old tech might struggle more.
• Getting accurate future economy guesses is hard, especially in changing times.
• RBI gives five years to ease it, but banks must train staff and change how they work.