ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Predicting the Probability of Default for Banks’ Expected Credit Loss Provisions

Banks can effectively utilise the internal credit-rating migration trend to predict the future risk of default for corporate loans. This will enable them to more proactively identify credit impairment and make necessary forward-looking loss provisions.

Credit risk assessment plays an important role in ensuring the profitability, soundness, and stability of any financial institution. The large losses incurred by the banks during the global financial crisis urged the accounting standard setters the world over, including the International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB), to re-examine the incurred loss models for provisioning that the banks and financial institutions were following and redesign the guidance for provisioning which would be forward-looking and the expected credit loss (ECL) based on the International Financial Reporting Standard (IFRS) 9. India, too, has adopted IFRS 9 as Ind AS 109 mainly in the non-banking financial company (NBFC) segment. The proactive approach to make provisions on the probable losses even for the standard assets is a globally accepted prudent norm set by IFRS 9 standard. Recently, Shaktikanta Das, the Governor of Reserve Bank of India (RBI), highlighted the importance of keeping the expected loss-based forward-looking provisions for the safety of commercial banks in India. Currently, the RBI (2023) has issued a discussion paper on ECL-based approach for loan loss provisioning by the banks. The governor had already indicated this after announcing the bimonthly policy review held on 30 September 2022.

International evidence suggests that the incurred loss approach favoured a belated recognition of the problem that led to an absence of prompt corrective action and forbearance. It allowed banks to avoid booking losses for non-performing loans that were existing on their balance sheets. In the worst scenario, it also encouraged to sustain zombie lending.1 Adaptation of IFRS 9 would benefit Indian commercial banks by improving their internal credit risk management process.

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Published On : 20th Jan, 2024

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