Fitch Ratings has said long-term benefits to the Indian banking sector from the implementation of the International Financial Reporting Standards (IFRS) accounting standards should outweigh short-term risks. The transition will probably negatively affect banks’ capital levels, as more impairment charges are front-loaded, but should bring qualitative benefits in credit risk management over the longer term.
It stated the adoption of IFRS is unlikely to drive rating changes in and of itself, but specific banks’ capital and risk management responses could influence their standalone Viability Rating. The RBI introduced a discussion paper last week that suggested banks make provisions for bad loans using the expected credit loss (ECL) method. Fitch believes the transition to ECL provisioning is the most important aspect, from a credit perspective, of adopting IFRS and shows the RBI's intent to switch accounting standards.
It mentioned the ECL framework primarily addresses the problem of procyclical provisions as banks are required to estimate ECL ahead of adverse credit events, instead of making provisions after loans have become impaired, as is the current norm. Besides, the rating agency believes the RBI will smoothen the process of adopting ECL provisioning over up to five years. It noted banks would have little room to absorb unexpected stress if they increased provisioning requirements by running down capital ratios closer to regulatory thresholds.
