Mumbai: Banks will be required to set aside funds for potential loan defaults in advance starting April 2027, using mathematical models to predict losses rather than waiting for actual defaults, according to the Reserve Bank of India's (RBI) final rules issued on April 27, 2026. These norms, while softening some earlier proposals, represent a significant shift in how non-performing assets are recognized.
Key Changes in the New Framework
The new system moves away from the current practice of recognizing losses only after a default occurs to a forward-looking approach called 'expected credit loss' (ECL), where risks are estimated earlier. Although stricter than existing norms, the final guidelines are less stringent than the draft rules proposed in October 2025, reflecting a more balanced regulatory approach.
Expanded Scope
The scope of the rules has been widened. Initially, the draft mainly applied to large commercial banks, excluding smaller players like small finance banks. The final guidelines now include small finance banks within the framework, though payments banks, local area banks, and regional rural banks remain excluded.
Revised Assumptions
RBI has adjusted key assumptions used by banks when precise risk estimation is not possible. The minimum default risk that banks must assume has been slightly reduced. Additionally, loans backed by strong collateral such as cash, gold, and government securities will now be treated more favorably, requiring banks to set aside less money against such loans than originally proposed.
Implementation Timeline
Banks will begin following the new system from April 1, 2027, but will have until March 31, 2030, to fully transition their existing loans to the new interest calculation method. At the time of transition, banks must reassess the value of all their loans, with any impact adjusted directly in their reserves rather than affecting their profit and loss accounts.
Impact on Banks
According to Suresh Ganapathy, an analyst with Macquarie Group, the one-time impact could be around 5-10% of public sector banks' net worth. RBI has allowed this impact to be absorbed through reserves with a four-year amortization period. For private sector banks, the impact will be minimal, and contingent provisions can be used for set-off. Banks are generally well-capitalized, with system Common Equity Tier 1 (CET1) at over 13%, enabling them to absorb the transition impact easily.
Other Key Provisions
If a borrower who had defaulted becomes regular and shows no signs of stress, banks can now move the account directly back to a standard category. The earlier proposal requiring a waiting period before such upgrades has been removed. For credit lines like overdrafts or credit cards, if the borrower exceeds limits for 60 days, it may now be treated as a sign of rising risk.
Enhanced Classification and Oversight
The final norms also classify loans more clearly to avoid mixing low-risk and high-risk assets. There will be tighter oversight of the models banks use to predict losses. Banks must maintain a detailed list of these models, classify them based on importance, and ensure checks at three levels: businesses, risk managers, and internal auditors.
