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      Question

      According to RBIā€™s discussion paper on the Expected

      Credit Loss (ECL) model for banks, how should the transitional adjustment amount be treated at the time of adopting the ECL framework?
      A It should be deducted from the Common Equity Tier 1 (CET 1) capital. Correct Answer Incorrect Answer
      B It should be excluded from the calculation of capital ratios. Correct Answer Incorrect Answer
      C It should be added back to the CET 1 capital. Correct Answer Incorrect Answer
      D It should be treated as a separate provision and accounted for independently. Correct Answer Incorrect Answer
      E The treatment of the transitional adjustment amount is not specified. Correct Answer Incorrect Answer

      Solution

      The transitional adjustment amount represents the difference between: ā€¢ Provisions computed under the extant incurred loss-based provisioning norms, and ā€¢ Provisions required under the newly proposed Expected Credit Loss (ECL) framework, net of tax effects. As per the RBIā€™s discussion paper: ā€¢ This transitional adjustment amount will be added back to the Common Equity Tier 1 (CET 1) capital. ā€¢ The relief is temporary and will be phased out over a maximum of five years, though banks may choose a shorter transition period. ā€¢ This approach provides banks with capital adequacy relief during the initial years of implementation, ensuring a smoother transition to the ECL model. Thus, the recommended treatment is to add back the transitional adjustment amount to CET 1 capital.

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