RBI is reviewing Expected Credit Loss (ECL) framework after rating agencies breached Observed Default Rate (ODR) thresholds for BB-rated companies. All seven rating agencies exceeded BB category's 0.40-1% ODR benchmark, forcing banks to assign 150% risk weights instead of 100% to SME borrowers. This increases borrowing costs for small and mid-sized firms despite unchanged individual ratings. Framework uses four-year historical data from April 2023-March 2027, covering global conflicts and supply chain disruptions period.

The ECL framework was designed to improve rating discipline by linking bank capital requirements to rating agency performance through ODR criteria. When agencies breach default thresholds, banks must apply higher risk weights to entire rating categories, not individual borrowers. This creates a systemic penalty where all BB-rated SMEs face higher borrowing costs due to collective agency performance, even if their own creditworthiness hasn't deteriorated. The timing is problematic as the framework uses historical data from a period marked by COVID-19 recovery, global conflicts, and supply chain disruptions, potentially overstating default risks. For SMEs already stressed by West Asia crisis impacts, this could restrict credit access when they need it most. The framework also creates competitive distortions, potentially driving borrowers toward larger rating agencies and weakening market competition. Rating agencies argue for a more prospective approach rather than backward-looking data dependency. Additionally, inconsistencies between RBI and SEBI benchmarks could lead to different treatment of the same borrower across loans and bonds, creating regulatory arbitrage opportunities.