Current crisis worst of century: RBI
Banks must conduct stress tests, ensuring stability of financial system paramount, says Das
Reserve Bank of India (RBI) governor Shaktikanta Das asked banks and finance companies on Saturday to conduct so-called stress tests even as he emphasised that the central bank’s primary focus will be on reviving growth and ensuring the stability of the financial system.
The economic fallout of the coronavirus disease pandemic may lead to higher non-performing assets, or bad loans, and capital erosion at Indian banks, he warned, terming the Covid-19 outbreak the worst economic and health crisis in a century.
A recapitalisation plan for public sector banks and private banks has become necessary because of the compression in economic growth during and after the Covid-19 lockdown, Das said at the seventh banking and economics conclave organised by the State Bank of India (SBI), stressing the need for banks to raise capital and build cash buffers to ensure credit flow and resilience of the financial system, and to be prepared for more frequent and bigger risk events.
“While the NBFC [non-banking financial company] sector as a whole may still look resilient, the redemption pressure on NBFCS and mutual funds needs close monitoring,” Das said at the digital conference, referring to the emerging stress points in the financial system. “Mutual funds have emerged as major investors in market instruments issued by NBFCS, which is why the development of an adverse feedback loop and the associated systemic risk warrants timely and targeted policy interventions.”
“Increasing share of bank lending to NBFCS and the continuing crunch in market-based financing faced by the NBFCS and Housing Finance Companies (HFCS) also need to be watched carefully,” the RBI governor cautioned.
The RBI governor ended his
speech on a cautiously optimistic note, saying the financial system was functioning well and the economy had started showing signs of getting back to normalcy after the easing of lockdown restrictions. “It is, however, still uncertain when supply chains will be restored fully; how long will it take for demand conditions to normalise; and what kind of durable effects the pandemic will leave behind on our potential growth.”
The need of the hour is to restore confidence, preserve financial stability, revive growth and recover stronger, he added.
Das said: “While the multipronged approach adopted by the Reserve Bank has provided a cushion from the immediate impact of the pandemic on banks, the medium-term outlook is uncertain and depends on the Covid-19 curve. Policy action for the medium-term would require a careful assessment of how the crisis unfolds. Building buffers and raising capital will be crucial not only to ensure credit flow but also to build resilience in the financial system.”
India’s economy, which was already in the grip of a slowdown when the outbreak began at the end of last year in the central Chinese city of Wuhan and spread rapidly around the world, grew 3.1% in the quarter ended March from a year ago and 4.2% in the full fiscal year.
India’s economy will likely shrink 5% in the year through next March, Goldman Sachs said in a report in the last week of May. The International Monetary Fund has slashed its 2020-21 growth projection for India to 1.9% from 5.8% estimated in January.
“We have recently [19th June and 1st July, 2020] advised all banks, non-deposit taking NBFCS [with an asset size of ₹5,000 crore] and all deposit-taking NBFCS to assess the impact of COVID-19 on their balance sheet, asset quality, liquidity, profitability and capital adequacy for the financial year 2020-21. Based on the outcome of such stress testing, banks and non-banking financial companies have been advised to work out possible mitigating measures including capital planning, capital raising, and contingency liquidity planning, among others. The idea is to ensure continued credit supply to different sectors of the economy and maintain financial stability,” Das said in his speech, a transcript of which was posted on the RBI website.
The growth woes began much before Covid-19 struck. In September 2018, Infrastructure Leasing and Financial Services Ltd, a major lender to all kinds of businesses, defaulted on its debt obligations, triggering a rippling liquidity crisis in the financial services market. Borrowing costs rose sharply.
Private demand began collapsing too.
“The outbreak of Covid-19 pandemic is unambiguously the worst health and economic crisis in the last 100 years during peace time with unprecedented negative consequences for output, jobs and well-being. It has dented the existing world order, global value chains, labour and capital movements across globe and needless to say, the socio-economic conditions of a large section of world population,” Das further added.
RBI has cut its key interest rate by 115 basis points (BPS) since the coronavirus crisis began, having pared it by 135 BPS between February 2019 and the onset of the pandemic. One basis point is one-hundredth of a percentage point.
The liquidity measures announced by RBI since February 2020, after the onset of Covid-19, aggregate to about ₹9.57 lakh crore, equivalent to about 4.7% of the 2019-20 nominal gross domestic product, according to Das, a former civil servant in the central government who was appointed the RBI governor in December 2018 to replace Urjit Patel, who resigned over differences with the government.
“Consistent with this [accommodative] policy stance, liquidity conditions were also kept in ample surplus all through since June 2019. The lagged impact of these measures was about to propel a cyclical turnaround in economic activity when Covid-19 brought with it calamitous misery, endangering both life and livelihood of people,” Das said.
Heading into the pandemic, the financial system was in a much improved position, owing mainly to various regulatory and supervisory initiatives of the Reserve Bank, he said.