A turning point for the financial sector

The uncertainty about growth, possible surge in NPAS will add to the crisis

In a speech on Saturday, Reserve Bank of India (RBI) governor Shaktikanta Das pointed out that the pandemic could fritter away the gains made so far on the non-performing assets (NPA) front. The gross NPA ratio for scheduled commercial banks improved from 9.1% in March 2019 to 8.3% in March 2020. The economic disruption will impair the timely repayment of loans and, therefore, worsen the NPA crisis.

While this is not surprising, the governor also said that it was uncertain when supply chains would be restored fully; when demand would get normalised; and “what kind of durable effects the pandemic will leave behind on our potential growth”. While the first two concern immediate economic recovery, durable effects on potential growth have policy implications. For example, RBI’S monetary policy framework, which must keep inflation within two percentage points of the mandated 4% level, uses an inflation-targeting model. This requires a potential growth rate. Any significant change to this variable will render the present framework infructuous. The governor also pointed out how shocks to the financial system “dubbed as once in a lifetime events” seemed to be have become more frequent than even once in a decade. This, he said, means that the minimum capital requirement of banks may no longer be considered sufficient to absorb the losses. If the banks do not know about the rest of the economy, which is what uncertainty about potential growth means, and the economy does not know about the banks, which is what capital requirements becoming inadequate imply, it suggests India is entering into hitherto uncharted territory.