Moving Towards a More Risk-Sensitive Banking System, the Reserve Bank of India (RBI) has released two important draft directions to strengthen the prudential framework for credit risk assessment and provisioning in line with international best practices under the Basel III reforms.

1. Draft Directions on Capital Charge for Credit Risk – Standardised Approach (2025)

Aligning with the Basel Committee on Banking Supervision’s Basel III:

Finalising Post-Crisis Reforms (2017), the RBI proposes to implement the Standardised Approach (SA) for calculating risk-based capital requirements for credit risk in Indian banks.

The revised framework aims to enhance **risk sensitivity, comparability, and robustness in capital computation.

Key proposed changes include:

* Granular risk weighting for exposures to corporates, MSMEs, and real estate.

* Inclusion of ‘transactors’—credit card users with a consistent repayment record—in the regulatory retail category.

* Revised credit conversion factors for off-balance-sheet exposures.

* Risk-weight adjustments based on the default experience of credit rating agencies, supported by banks’ due diligence.

These revisions are expected to reduce the minimum capital requirements for certain portfolios, notably MSME, real estate, and credit card exposures, thereby promoting greater credit flow to these sectors.

2. Draft Directions on Asset Classification, Provisioning, and Income Recognition (2025)

The second draft proposes a major shift from the incurred loss-based provisioning framework to an Expected Credit Loss (ECL) approach, marking a significant step toward international accounting and regulatory convergence.

Key features of the ECL-based framework include:

* Three-stage asset classification under the ECL model, while retaining current norms for Non-Performing Assets (NPAs).

* Calibrated prudential floors for each stage and exposure class to ensure consistent provisioning levels.

* Alignment of income recognition norms with the Effective Interest Rate (EIR) methodology.

* Model risk management principles for banks implementing ECL estimation models.

While a one-time increase in provisioning may occur during transition, the RBI has proposed a five-year glide path to ensure a smooth and non-disruptive implementation. The overall capital adequacy of banks is expected to remain comfortably above regulatory minima.

Conclusion

These draft directions collectively reflect the RBI’s commitment to enhancing the resilience and transparency of India’s banking sector. By improving the accuracy of credit risk assessment and provisioning practices, the reforms aim to align domestic regulations with global standards, facilitate more efficient capital allocation, and strengthen long-term financial stability.