RBI's Expected Credit Loss Framework to Create Recurring Profitability Drag on Indian Banks

The Reserve Bank of India's new Expected Credit Loss framework presents a recurring drag on bank profitability, not a one-time capital hit. Public Sector Undertaking (PSU) banks are more exposed due to unchanged provisioning floor rates, potentially impacting their return on assets. While some private banks have buffers, others face a sharper impact.

The Reserve Bank of India's Expected Credit Loss framework has been formally announced, and the banking sector is now doing the math on what it actually costs. Punit Bahlani, Vice President at Dolat Capital, says the bigger concern is not the one-time capital hit — it is the recurring drag on profitability that will separate well-prepared banks from the rest.

The two hits every bank must absorb

Bahlani draws a clear distinction between two separate impacts. The first is the hit to net worth, which PSU banks themselves disclosed during their third quarter earnings calls after draft norms were released. The industry-wide estimate sits at 7–10% of net worth — significant on paper, but manageable given that PSU banks are running Tier-I capital ratios above 13% on average, and the broader industry including private banks is above 15%. With a four-to-five year transition period allowing banks to phase in the impact in roughly equal annual instalments, this one-time capital concern is not what worries Bahlani.

The second hit — the recurring incremental credit cost charged to the profit and loss account — is the one to watch. This directly compresses Return on Assets and is where the real divergence between banks will emerge.

Why PSU banks are more exposed

The market had widely expected RBI to water down the provisioning floor rates in the final circular. That did not happen. RBI kept the floor rates unchanged, meaning that even if a bank's internal ECL model suggests lower provisions for Stage two assets, they must still carry the prescribed minimum floor. This is disproportionately negative for PSU banks, which have not built contingent provision buffers on their balance sheets and will have no cushion to absorb this incremental cost.

Bahlani estimates the recurring impact for PSU banks at 15–25 basis points on credit costs. Bank of Baroda flagged approximately 20 basis points in its third quarter earnings call, which the street is now using as a working baseline. For SBI, which has better historical asset quality, the impact could be closer to 15 basis points. Either way, Bahlani is direct about the consequence: even at the lower end of 15 basis points, it becomes difficult for PSU banks to sustain return on assets above 1%.

Private banks: A tale of two groups

Within private banks, the picture is more nuanced. HDFC Bank, ICICI Bank, and Axis Bank are relatively better positioned, having built substantial contingent provision buffers — HDFC Bank's buffer is estimated at Rs 20,000–25,000 crore, while ICICI Bank carries approximately Rs 13,000 crore. Axis Bank recently added to its contingent reserves as well, partly in response to West Asia conflict risks. These buffers provide meaningful insulation against the ECL transition.

However, banks like Kotak Mahindra Bank carry negligible contingent buffers and will face a more direct impact. Mid-size lenders including DCB Bank, RBL Bank, and City Union Bank have also not provisioned adequately and are likely to feel a sharper hit relative to their size.

The net impact is lower than headlines suggest

Bahlani also flags an important offset. RBI's simultaneous circular reducing risk weights on certain corporate exposures, home loans, mortgages, and SME loans against property will release capital for banks. When netted against the ECL provisioning requirement, the actual impact on net worth will be meaningfully lower than the headline 7–10% figure.

The bottom line: capital adequacy is not the crisis. Margin compression on recurring earnings is — and that is what investors should be tracking bank by bank through the FY26 results cycle.