At the center of the discussion is the Observed Default Rate (ODR) mechanism introduced under RBI’s new Basel III credit risk framework. The framework links the risk weight assigned to rated corporate exposures not only to the borrower’s credit rating but also to the historical performance of the rating agency that assigned the rating.

The objective is to improve rating quality and make risk assessment more sensitive to actual default experience. However, industry participants fear that the framework’s implementation could have unintended consequences for SME financing.

Why this matters for SMEs:

• A Framework Designed to Provide Relief: Under the revised Basel III framework, certain BBB and BB-rated corporate exposures could benefit from lower risk weights compared to the existing system. Lower risk weights reduce the capital banks need to hold against such loans, potentially supporting greater credit availability.
• The ODR Challenge: These benefits are available only if rating agencies meet RBI’s prescribed default-rate benchmarks. If a rating agency’s observed default rate exceeds the threshold for a particular rating category, banks may have to apply higher risk weights to loans rated by that agency within that category.
• Potential Impact on Borrowing Costs: Higher risk weights increase the regulatory capital banks must maintain. While RBI does not mandate higher lending rates, increased capital consumption can affect loan pricing and lending appetite, particularly for SMEs and mid-market businesses concentrated in BBB and BB rating categories.
• Industry Seeking Refinements: Banks and rating agencies have reportedly suggested that historical default data may not fully reflect future credit quality, especially after recent periods marked by supply chain disruptions, geopolitical uncertainty, and economic volatility. Stakeholders are therefore seeking a more balanced and forward-looking approach to ODR calibration.

Current Status & Timeline:

The Basel III Credit Risk Framework and the ECL framework have been finalized and are scheduled to come into effect on April 1, 2027. A phased transition approach is expected to continue over the subsequent years.

While the implementation timeline remains unchanged, RBI is reportedly examining industry feedback regarding the ODR-linked risk weight mechanism. The objective is to strengthen risk management and rating accountability while ensuring that viable SMEs do not face unintended increases in borrowing costs.

For SMEs, the development highlights a growing reality: access to affordable credit is increasingly influenced not only by a company’s own financial performance but also by the regulatory and risk assessment frameworks that shape how banks allocate capital.

Sources:

Economic Times, RBI Credit Risk (Standardised Approach) Directions 2026, RBI Expected Credit Loss (ECL) Directions, CRISIL Ratings Analysis, ICRA Research, KPMG India Analysis. Thanks to Sangita Mehta, The Economic Times, for breaking the developments on the RBI’s review of the ECL rules and SME credit concerns.  

To stay updated with trends impacting MSMEs, businesses, and entrepreneurs, 

follow 𝐌𝐒𝐌𝐄 𝐓𝐀𝐋𝐊® on:

YouTube: https://www.youtube.com/@msmetalk 

LinkedIn: https://www.linkedin.com/company/msmetalk

Stay Updated:

Subscribe Newsletter: https://msmetalk.com/subscription-alert/

WhatsApp Channel: https://whatsapp.com/channel/0029VbAPTDw7dmeS3LWrYD1t

WhatsApp group: https://chat.whatsapp.com/HBcTRj9pNFPIwgFzk3hGwv

Connect with us :

Email: connect@msmetalk.com

WhatsApp connect: https://wa.me/918097665085