Expected loss model: PSBs may seek pause on paying govt dividends

Public sector banks (PSBs) are considering asking the government to allow them to not pay it a dividend as they look to conserve capital before the expected loss-based approach for loan loss provisioning kicks in, likely from April 1, 2025.

In January, the Reserve Bank of India (RBI) released a discussion paper on the expected loss-based approach for loan loss provisioning. Last week, the government asked public sector banks to conduct a detailed study on the impact of such a norm on their capital position.

At present, banks make provisions on incurred loss, that is, once an account is overdue for more than 90 days, they set aside capital, known as provision.

In the expected loss model, banks need to make provision once an account shows signs of stress, even if the account is standard. This would result in an increase in banks’ capital requirement as they have to make provision for certain standard assets that are showing signs of stress. 

In the discussion paper, the RBI said banks will be given one year to prepare themselves before implementing the framework. The regulator is open to the idea of giving banks five years to spread the provisioning requirement.

According to bankers, while some might be comfortable on capital for some other lenders the capital position could erode significantly as a result. For large public sector banks, additional capital requirements will be around Rs 6,000 crore.

At the same time, banks want the government to allow them not to share dividends to conserve capital before the new norms kicks in.

“One way to conserve capital is to hold back the dividend. Our capital requirement will go up since we have made provision for standard assets,” said another banker from a PSB.

After not paying dividends for three financial years – financial year 2017-18 (FY18), FY19, and FY20 – PSBs paid dividends in the next two financial years as they returned to profitability on the back of a decline in non-performing assets (NPAs).

PSBs’ profits have increased in the last two years, after a prolonged period of losses due to sharp rise in NPAs. Gross NPAs of Indian banks rose to 11.5 per cent in March 2018, but have since declined. According to RBI data, banks’ gross NPA was at 5 per cent as of September 2022.

“If you look at the last five years or so, Indian banks are perhaps in their best health in terms of balance sheet strength to absorb any increase in provisioning that may be required on account the proposed ECL framework,” said Krishnan Sitaraman, senior director and deputy chief ratings officer, CRISIL Ratings.

Sitaraman said banks’ provisioning cover ratio was close to 75 per cent — the highest in about the last 25 years.

“So, current provisioning cover for NPAs is reasonably high. The capitalisation levels are quite healthy relative to the last few years and the improvement has been seen for PSBs as well,” he said.

With increase in profitability and decline in bad loans, Sitaraman says it was possibly the most “optimal” time to implement such a norm. At the same time, there would be an increase in provisioning.

“Yes, we do envisage that there will be some increase in the provisioning level due to the new framework as standard assets will also have to be provided for and there would be a prudential floor as well for provisioning. To what extent the increase in provisions would be, will depend on the final guidelines,” Sitaraman told Business Standard.

Feedback on the discussion paper was sought by February 28. The regulator will now announce the draft guidelines, for which feedback will be sought again. Then the final guidelines will be announced, which is expected in the next financial year.

Rating agency ICRA, which expects the implementation of the expected loss model to be an important step in the shift to the Indian Accounting Standards (IND-AS) regime, said the norms are likely to kick in from April 1, 2025.