Set aside funds for likely defaults, RBI tells banks

Mumbai: Banks will have to start setting aside money for possible loan defaults in advance from April 2027, using mathematical models to predict losses instead of waiting for borrowers to actually miss payments, under RBI's final rules issued on April 27, 2026. These norms soften some earlier proposals but still mark a major shift in how bad loans are recognised.

The new system moves banks away from the current practice of recognising losses only after a default happens, to a forward-looking approach called 'expected credit loss', where risks are estimated earlier. While the norms are stricter than what banks follow today, they are less harsh than the draft rules proposed in Oct 2025, reflecting a more balanced approach by the regulator.

The scope of the rules has also been widened. Earlier, 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, although payments banks, local area banks and regional rural banks are still kept out.

RBI has also tweaked key assumptions that banks use when they cannot estimate risks precisely. The minimum default risk that banks must assume has been slightly lowered. At the same time, loans backed by strong collateral such as cash, gold and govt securities will now be treated more favourably, meaning banks will need to set aside less money against such loans than earlier proposed.

On implementation, banks will start following the new system from April 1, 2027, but will get time until March 31, 2030 to fully shift their existing loans to the new interest calculation method. At the time of transition, banks will also need to reassess the value of all their loans, with any impact adjusted directly in their reserves instead of affecting their profit and loss accounts.

"One-time impact could be around 5-10% for PSU banks' net-worth, and RBI has allowed to take it through reserves with a 4-year amortisation period. For private sector banks, impact will be very small and possibly contingent provisions can be used for set-off. Banks in general are very well capitalised with system CET1 at 13%+ and hence they can easily absorb the transition hit," said Suresh Ganapathy, an analyst with Macquarie Group.

If a borrower who had defaulted becomes regular again and shows no signs of stress, banks can now move the account directly back to a standard category. The earlier proposal that required a waiting period before such upgrades has been removed. For credit lines like overdrafts or credit cards, the rules now say that if the borrower exceeds limits for 60 days, it may now be treated as a sign of rising risk.

The final norms also classify loans more clearly to avoid mixing low-risk and high-risk assets. There will also be tighter oversight of the models banks will use to predict losses. Banks will now have to maintain a detailed list of these models, classify them based on importance, and ensure checks at three levels: businesses, risk managers and internal auditors.

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