Indian banks prep for new provisioning norms with strong asset quality, capital

Healthy credit quality and ample capital makes large Indian lenders adequately prepared to transition to the expected credit loss-based provisioning framework due in a little over one year.

Bad loans at most Indian banks have declined, bringing the aggregate nonperforming assets (NPA) ratio in the industry to its lowest level in a decade as the Reserve Bank of India tightened regulatory oversight in recent years to require banks to improve asset quality and strengthen balance sheets. Capital buffers remain above regulatory requirements and provisions already cover three quarters of potential stress scenarios.

In October 2025, India's central bank announced several credit reforms to "enhance credit risk management practices [and] promote better comparability of reported financials across institutions." The measures include a proposal to implement the expected credit loss (ECL)-based framework in a phased manner, starting in April 1, 2027.

"This proposed change is more cultural, as it compels banks to anticipate risk rather than react to it — strengthening resilience and aligning India's financial ecosystem with global standards, namely, IFRS 9," said Arun Sundar, associate partner at MGC Global Risk Advisory. "While the transition may temporarily elevate provisioning and capital requirements, it ultimately promises a more stable, transparent and risk-aware banking system."

Forward looking

The ECL methodology introduces forward-looking provisioning, unlike the current system that requires Indian banks to provide for loans only after they become nonperforming. The new rules will comply with the recommendations of the International Accounting Standards Board (IASB), which require banks to estimate the expected loss on a loan over its lifetime, instead of waiting for a default before setting funds aside. India is now behind most economies in Asia-Pacific that have already implemented the ECL framework under IASB's IFRS 9 financial instruments.

The concept is not entirely new in India. Nonbank financial companies are already subjected to ECL requirements, said Rahul Ghosh, CEO of RiskMaC Consulting, a Mumbai-based firm that advises companies on risk. "Different banks can be expected to be at varying stages of preparedness," Ghosh said. "[A] good number will find the transition a challenge because it is not just a matter of accounting change. It requires models, processes, implementation and governance," Ghosh added.

State Bank of India, India's largest lender by assets, reduced its NPA ratio in the past two years by 50 basis points to 1.15% in the fiscal year ended March 2025. The ratio is expected to further improve to 1.07% by March 2028, according to estimates by Visible Alpha, a part of S&P Global Market Intelligence. Most of its state-owned peers are also expected to improve their NPA ratios, Visible Alpha estimates show. The NPAs at private sector lenders are expected to remain low.

"The impact of the new draft ECL framework will be limited, given the benign asset quality trend of the past five years (except in unsecured retail loans)," said Anand Dama, analyst at Emkay Global, in an October 2025 note. "[The measures] provide ample time to further build provision buffers before implementation starts on April 1, 2027."

Loan staging

The ECL rules will require banks to make additional provisions for loans in different stages before they become nonperforming. The regulator set a five-year timeline for a smooth transition and also prescribed prudential floors for the three stages of credit risk.

For stage 1 loans, considered performing, banks must provide for 12 months of expected losses. Provisioning requirements are largely similar to existing norms for standard assets across loan categories. Loans with increased credit risk are classified as S=stage 2. The minimum provisioning requirements for most loans in the stage 2 bucket will rise to 5% from about 0.4% now. Stage 3 loans are credit-impaired, with provisioning requirements largely aligned with existing norms for nonperforming assets.

The classification of stage 2 loans is expected to require a significant increase in provisioning across the banking system, as banks will need to provide for expected losses over the entire life of these loans.

"What makes this framework transformational is its emphasis on stages 1 and 2, which were largely ignored under the current system," Amit Tyagi, financial risk manager at Bank of India, said in an interview with S&P Global Market Intelligence. "For instance, a 60-day overdue account that earlier attracted a mere 0.25%–0.4% provision could now require 5%, a tenfold increase."

Capital impact

The new rules are likely to affect the capital adequacy ratios (CARs) of Indian banks, though most lenders have enough cushion.

Indian "banks are well capitalized," said Arindam Bandyopadhyay, a professor at the National Institute of Bank Management, based in Pune, India. Both ECL and Basel III risk weights provide benefits to micro, small and medium enterprises, housing loans and other retail segments, Bandyopadhyay said.

The aggregate CAR of the four major private sector lenders stood at 18.26% as of September 2025, compared with 15.56% for state-owned banks, according to Market Intelligence data.

"All three stages put together, a rough estimate is in the range of around 75-80-bps impact will come on our CAR," said Punjab National Bank CEO Ashok Chandra during the bank's Oct. 18, 2025, earnings call. "And we are well-prepared for that, because anyway, that has to be split for five years."

The central bank has also proposed a more granular approach to calculating capital charges for credit risk, in line with Basel III guidelines. The revised framework will factor in borrower credit ratings, loan-to-value ratios for real estate loans and the quality of due diligence.

These changes are expected to reduce risk weights on loans to rated corporates, credit card customers, and micro, small and medium-sized enterprises, while marginally increasing them for unsecured and real estate loans.

Some impact on specific provisions for both stage 1 and stage 2 assets can be expected, Bandyopadhyay said. "Banks need to focus on forward-looking capital planning that aligns well with their business projection and risk appetite."

The move is likely to free up capital and offset part of the ECL-related impact, as the revised capital framework and ECL norms are expected to be implemented together.

Ankit Bihani, an analyst at Nomura, expects an improvement of 60-120 bps in common equity Tier 1 (CET1) ratios, solely due to lower risk weights. "We expect CET1 ratios to improve on account of lower risk weights on various loan products, which should largely offset the adverse impact on CET1 from the implementation of ECL norms," Bihani said in an October 2025 note.

Gearing up

Banks have already begun taking steps to soften the effect of the transition. Private sector lenders such as Axis Bank Ltd., HDFC Bank Ltd. and ICICI Bank Ltd. already carry sizable contingent and floating provisions, which are expected to help cushion the impact.

"The only impact we are likely to see on account of ECL is the shift from provisioning from outstanding to exposure," Axis Bank CFO Puneet Mahendra Sharma said at the fiscal second-quarter earnings call, citing the last pro forma assessment the bank did. "The impact is likely to be negligible on our net worth."

State-owned banks may feel a relatively bigger squeeze, as they typically operate with thinner capital buffers and have lower existing provisions. Many have started front-loading provisions to spread the impact during the transition period.

For example, Punjab National Bank estimates it may need an additional 90 billion Indian rupees to 100 billion rupees in provisioning under the ECL framework.

"That is the total capital that is required for the full implementation to happen in the five-year period," Punjab National Bank's Chandra said. The bank has used one-off gains over the past two quarters to build floating provisions of 17.75 billion rupees as part of its ECL preparation.

"With that in place, I think every quarter, we will have something where we will keep extra for the floating provision. … When the ECL gets implemented, we will adjust this floating provision against that ECL as per the Reserve Bank of India guidelines," Chandra said.

Bank of Baroda Ltd., another state-owned lender, added 4 billion rupees to its floating provision pool in the July-September 2025 quarter, raising the total to 10 billion rupees. The bank plans to continue building this buffer as it expects about a 75-bps net impact on CET1 from the draft ECL and capital charge guidelines.

The State Bank of India expects the most pronounced impact to arise from loans overdue by one to three months, as these "are not significantly provided" under the current model.

"We do have some buffers on the excess provisioning on the standard assets," said State Bank of India Chairman Challa Sreenivasulu Setty during the bank's Nov. 4, 2025, earnings call. "The impact can be reduced by strengthening our collection mechanism," Setty added.

Cultural shift

Beyond the numbers, the reforms are expected to trigger a broader cultural shift in how banks assess and manage credit risk, according to industry experts.

Risk parameters used internally, such as probability of default, will also feed directly into ECL provisioning, discouraging aggressive underwriting and formalizing internal credit rating systems.

"Microfinance and unsecured lending will surely put pressure once ECL is implemented in full. Though with better underwriting of assets, such scenarios are well taken care of," Bank of India's Tyagi said.

The framework will also test the robustness of banks' internal risk models, requiring them to define assumptions for default probabilities, recovery rates and macroeconomic scenarios. This is likely to invite closer regulatory scrutiny and could introduce greater earnings volatility.

"The real challenge for banks lies not in compliance, but in how effectively they adapt," said MGC Global Risk Advisory's Sundar. "The ECL framework will test their capacity to leverage data, enhance credit analytics and embed foresight into every risk decision."

– Click here for aggregate financial highlights of Indian banks. – Click here for more news articles on banking in the Asia-Pacific region. – Click here for economic and demographic data on India.