The Indian banking system has to be liberated from the risk aversion that is impeding the flow of credit to the productive sectors of the economy and undermining the role of banks as the principal financial intermediaries, the RBI said in its latest annual report.

The central bank observed that deterioration in macroeconomic and financial environment is impinging on asset quality, capital adequacy and profitability of banks.

“Regulatory dispensations that the pandemic has necessitated in terms of the moratorium on loan instalments, deferment of interest payments and restructuring may also have implications for the financial health of banks, unless they are closely monitored and judiciously used,” the RBI cautioned.

Although gross and net non-performing asset ratios had come down in March 2020, along with receding slippage ratios, the central bank opined that the economic fallout of the pandemic is likely to test this resilience, especially since the regulatory accommodations announced in the wake of the outbreak have masked the consequent build-up of stress.

NPAs to surge

Macro stress tests reported in the RBI’s July 2020 Financial Stability Report suggest that non-performing assets may surge 1.5 times above their March 2020 levels under the baseline scenario and by 1.7 times in a very severely stressed scenario.

The system level CRAR (capital to risk weighted assets ratio) can drop to 13.3 per cent in March 2021 from its March 2020 level under the baseline scenario and to 11.8 per cent under the very severe stress scenario.

Recapitalisation plan

Against this backdrop, the RBI emphasised that a recapitalisation plan for public and private sector banks assumes critical importance.

“The minimum capital requirements, which are calibrated on the basis of historical loss events, may no longer suffice to absorb post-pandemic losses. The Reserve Bank has already advised banks and NBFCs to carry out Covid-19 stress tests and take necessary remedial measures proactively,” the report said.

The RBI believes that the ability to raise capital, as well as build resilience to ensure financial stability in anticipation of more frequent, varied and bigger risk events shall be contingent on the governance standards in banks, particularly on the strength of risk governance framework

The RBI underscored that there is clearly a need for diversifying financing options for India Inc.

“Alternatives to bank finance have to be assiduously cultivated – capital markets and FDI (foreign direct investment) offer opportunities to bring in investors with a relatively longer-term view that is conducive to attracting durable capital as well as embedded technology,” the central bank said.

In this regard, the RBI mentioned that the setting up of the National Investment and Infrastructure Fund (NIIF) in 2015 is a major strategic policy response in this direction.

Promotion of the corporate bond market, securitisation to enhance market-based solutions to the problem of stressed assets, and appropriate pricing and collection of user charges should continue to receive priority in policy attention.

In the context of Covid-19, the RBI is of the view that a big push to certain targeted mega infrastructure projects can reignite the economy.

There is also a need for expanded footprints for specialised NBFCs classified as Infrastructure Finance Companies.