Financial Stability Report: RBI

• 25 Jul 2020

Why in News

Recently, the Reserve Bank of India (RBI) released its Financial Stability Report (FSR) for the month of July 2020.

• The FSR reflects the collective assessment of the Sub-Committee of the Financial Stability and Development Council (FSDC - headed by the Governor of RBI) on risks to financial stability and the resilience of the financial system.
• The Report also discusses issues relating to development and regulation of the financial sector.

Key Points

• Increase in Bad Loans:
  
  • The RBI warned that the Gross Non-performing Assets (GNPA) ratio of all Scheduled Commercial Banks (SCBs) may increase from 8.5% in March 2020 to 12.5% by March 2021.
  • The GNPA ratio may also worsen to as high as 14.7% by the end of the current financial year, if the adverse economic impact of the Covid-19 pandemic would be ‘very severe’.
  • According to experts at least 5% of the moratorium loans could turn into NPA if Covid-19 impact persists in the economy.
    
    • In the wake of Covid-19, the RBI had announced a six months loan moratorium to all term loans. The moratorium was first given for March-May (2020) but was later extended to June-August (2020).
    • The Covid-19 lockdown had a significant impact on all industrial activities in the economy resulting in major income loss. This has impacted their loan repayment ability.
  • This may lead to Gross Domestic Product (GDP) contraction by 8.9% in 2020-21.
• Decreasing Capital Adequacy Ratio:
  
  • The RBI projected that Capital Adequacy Ratio (CAR) ratio could slide to 13.3% in March 2021 under the normal scenario and to 11.8% under the very severe stress scenario.
    
    • CAR is the ratio of a bank’s capital in relation to its risk weighted assets and current liabilities. It is also known as Capital-to-Risk Weighted Asset Ratio (CRAR). Indian SCBs are required to maintain a CAR of 9%.
  • Earlier the CAR of SCBs decreased to 14.8% in March 2020, from 15% in September 2019.
• Risk Aversion by Banks:
  
  • Risk aversion in Public Sector Bank (PSBs) was more as compared to private banks. PSBs chose to give money only to high-quality borrowers.
    
    • However, the risk aversion tendency is also increasing in private banks.
  • RBI has warned that extreme risk aversion would have adverse effects on the economy.
• Risk to Financial System:
  
  • The RBI said that the Indian financial system remained stable, despite the significant downside risks to economic prospects.
  • The downside risks to short term economic prospects are high due to the lockdown induced disruptions to both supply and demand side factors, diminished consumer confidence and risk aversion.
• Issues Involved:
  
  • Recently, the former RBI Governor Urjit Patel has criticised the government for diluting the Insolvency and Bankruptcy Code (IBC) and the powers of the RBI.
    
    • He has said that this has undermined the efforts made since 2014 to clean up the bad loan mess.
  • The government uses ownership of banks as a means for day-to-day macroeconomic management rather than primarily for efficient intermediation between savers and borrowers.
  • Banks have poor asset quality, lack of profitability, loss of capital, excessive risk exposure, poor conduct, and liquidity concerns.
  • There is also a lack of a mechanism to address bank failures.
  • Stress on Non-banking Finance Companies (NBFCs) and mutual funds is emerging as a strain on the financial system.
• Suggestions:
  
  • All the financial intermediaries need to assess the impact of Covid-19 on their balance sheet, asset quality, liquidity, profitability and capital adequacy for the FY 2020-21 and to work out possible mitigating measures.
    
    • The idea is to ensure continued credit supply to different sectors of the economy and maintain financial stability.
  • Financial intermediaries should make risk management in tune with the emerging contingencies.
    
    • The risk management includes, building buffers and raising capital, which will strengthen the internal defences of banks against the risks posed by Covid-19 and also ensure credit flow.
  • Recapitalisation plan for Public Sector Banks (PSBs) and private banks since the minimum capital requirements of banks may no longer be sufficient enough to absorb the losses.
    
    • The minimum capital requirements of banks are calibrated based on historical loss events.

Source: TH