RBI's move to reform regulatory framework set to bring good times for banks, says Fitch
October 14, 2025
The RBI plans to apply a forward-looking expected credit loss framework from April 2027, bringing the country in line with international standards.
MUMBAI: The major relaxations in the regulatory framework (as many as 21 regulations are getting amended) announced by the RBI on October 1 are positive for the financial sector as they will help strengthen the operating environment for banks with lesser burden on core capital, said Fitch Ratings in a note on Tuesday.
The biggest benefits are in the form of the expected credit loss framework that will come into force from April 2027 with more than enough leeway for banks to make provisions and the hit on profitability will be a very modest. An equally beneficial change is the aligning of domestic regulations with Basel III norms, which again is positive from the capital requirement perspective, said the agency.
The RBI plans to apply a forward-looking expected credit loss (ECL) framework from April 2027, moving away from the existing incurred-loss provisioning system and bringing the country in line with international standards. Banks will be allowed to smooth out provisioning adjustments until March 2031.
“We now estimate the system-wide impact of the move will be slightly less than we had assumed in August 2024, when we projected it would reduce common equity tier 1 (CET1) capital ratios by about 55 bps at the time of the switch, rising to 100s bps over the course of the transition period.
“The reform is unlikely to put meaningful pressure on rated banks’ capitalisation and leverage scores, one of the key rating drivers in our standalone viability rating (VR) assessment. Banks have been preparing for the adoption of ECL for many years. Their CET1 ratios and internal capital generation are close to cyclical highs, which should soften the impact on core capital,” Prakash Pandey, an associate director, banks, at the agency, said.
Forecasting only a modest hit to profitability from higher credit costs under ECL, he said banks’ VR scores for earnings and profitability are unlikely to be affected, as they should be able to absorb them without operating profit/risk-weighted asset (RWA) ratios falling significantly below our current forecasts.
“We expect this ratio to remain significantly higher for private banks than for state banks, due to better pre-impairment profitability. State banks’ credit costs, which are at a cyclical low, are likely to rise slightly more than those for private banks,” he said.
The impact of ECL adoption on CET1 and operating profit/RWA ratios may be mitigated by another reform: the introduction of revised Basel III risk-weights, with effect from April 2027. The change will result in lower risk-weights for some loan categories, including corporate, SME and home loans, and prime credit card borrowers.
Another reform will create an enabling framework for lending against securities and lending to finance corporate acquisitions. "The changes should give banks more business opportunities. Banks’ exposure to market risk may increase slightly, but with only a modest impact on risk profiles because we anticipate underwriting and exposure limits will remain conservative," he said.
The agency also believes the RBI’s decision to withdraw proposed restrictions on banks and their subsidiaries doing similar business provides banks with greater operational freedom, without necessarily increasing risks, because subsidiaries are also supervised by the RBI.
The RBI’s proposal to lower risk-weights on financing operational infrastructure assets may help free up regulatory capital for Tata Capital, which has a small portfolio of such loans. However, most rated non-banks are not significantly exposed to such lending.
The removal of the 450 bps cap over the benchmark for pricing foreign borrowings could allow lower-rated NBFCs to increase foreign-currency funding, subject to market risk appetite. Meanwhile, a proposal to allow NBFCs to raise over $750 million in foreign-currency funding annually, without prior regulatory approval, should ease the process for larger offshore debt-raising.
The biggest benefits are in the form of the expected credit loss framework that will come into force from April 2027 with more than enough leeway for banks to make provisions and the hit on profitability will be a very modest. An equally beneficial change is the aligning of domestic regulations with Basel III norms, which again is positive from the capital requirement perspective, said the agency.
The RBI plans to apply a forward-looking expected credit loss (ECL) framework from April 2027, moving away from the existing incurred-loss provisioning system and bringing the country in line with international standards. Banks will be allowed to smooth out provisioning adjustments until March 2031.
“We now estimate the system-wide impact of the move will be slightly less than we had assumed in August 2024, when we projected it would reduce common equity tier 1 (CET1) capital ratios by about 55 bps at the time of the switch, rising to 100s bps over the course of the transition period.
“The reform is unlikely to put meaningful pressure on rated banks’ capitalisation and leverage scores, one of the key rating drivers in our standalone viability rating (VR) assessment. Banks have been preparing for the adoption of ECL for many years. Their CET1 ratios and internal capital generation are close to cyclical highs, which should soften the impact on core capital,” Prakash Pandey, an associate director, banks, at the agency, said.
Forecasting only a modest hit to profitability from higher credit costs under ECL, he said banks’ VR scores for earnings and profitability are unlikely to be affected, as they should be able to absorb them without operating profit/risk-weighted asset (RWA) ratios falling significantly below our current forecasts.
“We expect this ratio to remain significantly higher for private banks than for state banks, due to better pre-impairment profitability. State banks’ credit costs, which are at a cyclical low, are likely to rise slightly more than those for private banks,” he said.
The impact of ECL adoption on CET1 and operating profit/RWA ratios may be mitigated by another reform: the introduction of revised Basel III risk-weights, with effect from April 2027. The change will result in lower risk-weights for some loan categories, including corporate, SME and home loans, and prime credit card borrowers.
Another reform will create an enabling framework for lending against securities and lending to finance corporate acquisitions. "The changes should give banks more business opportunities. Banks’ exposure to market risk may increase slightly, but with only a modest impact on risk profiles because we anticipate underwriting and exposure limits will remain conservative," he said.
The agency also believes the RBI’s decision to withdraw proposed restrictions on banks and their subsidiaries doing similar business provides banks with greater operational freedom, without necessarily increasing risks, because subsidiaries are also supervised by the RBI.
The RBI’s proposal to lower risk-weights on financing operational infrastructure assets may help free up regulatory capital for Tata Capital, which has a small portfolio of such loans. However, most rated non-banks are not significantly exposed to such lending.
The removal of the 450 bps cap over the benchmark for pricing foreign borrowings could allow lower-rated NBFCs to increase foreign-currency funding, subject to market risk appetite. Meanwhile, a proposal to allow NBFCs to raise over $750 million in foreign-currency funding annually, without prior regulatory approval, should ease the process for larger offshore debt-raising.