What changed
RBI reaffirmed that principal cash flows are part of the fair value diminution calculation for restructured advances, countering representations to exclude them. The circular also dismissed concerns that the existing methodology over-provisions due to general interest rate rises, stating the approach aligns with IAS 39 and AS 30.
What it means for you
Banks must continue to measure and provision for the full erosion in fair value of restructured loans, including principal cash flows. This prevents under-provisioning and ensures balance sheets reflect true economic loss, though it may strain margins during downturns.
What you must do
- Ensure restructuring packages include computation of fair value diminution using both principal and interest cash flows.
- Apply the discount rate as current BPLR plus term and credit risk premiums as specified.
- Debit the provision for diminution to the Profit & Loss Account immediately upon restructuring.
- Review existing restructured loan portfolios for compliance with this methodology.
Who it affects
All scheduled commercial banks (excluding RRBs and LABs), Bank credit and risk management teams, Loan restructuring departments
Why does RBI insist on including principal cash flows in fair value computation?
Excluding principal cash flows would understate the economic loss from restructuring, as elongation of repayment periods reduces the present value of the loan. This aligns with international accounting standards.
Does the new circular change the provisioning formula from 2008?
No, it reaffirms the existing formula from the August 2008 circular, rejecting industry suggestions to modify it. The discount rate remains BPLR plus term and credit risk premiums.