Build buffers, raise capital on anticipatory basis, says RBI Governor to banks

Reserve Bank of India (RBI) Governor Shaktikanta Das has asked banks and financial institutions to build buffers and raise capital on an anticipatory basis to deal with the economic impact, including higher bad loans and capital erosion due to the Covid-19 pandemic.

This will be crucial not only to ensure credit flow but also to build resilience in the financial system, the Governor said at State Bank of India’s 7th Banking and Economic Conclave.

Based on the outcome of the recent stress testing (to assess the impact of Covid-19), RBI has advised banks and non-banking finance companies (NBFCs) to work out possible mitigating measures including capital planning, capital raising, and contingency liquidity planning, among others.

Das said the idea is to ensure continued credit supply to different sectors of the economy and maintain financial stability.

He emphasised that: “A recapitalisation plan for public sector banks (PSBs) and private banks (PVBs) has, therefore, become necessary.”

“While the NBFC (non-banking finance company) sector as a whole may still look resilient, the redemption pressure on NBFCs and mutual funds need close monitoring.”

Referring to mutual funds emerging as major investors in market instruments issued by NBFCs, Das cautioned about the development of an adverse feedback loop and the associated systemic risk, which warrants timely and targeted policy interventions.

Further, 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.

Risk events: Fatter tails

Das observed that the global financial crisis of 2008-09 and the Covid-19 pandemic have dispelled the notion that tail risks to the financial system will materialise, only rarely.

“The probability distribution of risk events has much fatter tails than we think. Shocks to the financial system dubbed as ‘once in a lifetime events’ seem to be more frequent than even ‘once in a decade’,” he said.

In this regard, the Governor felt that the minimum capital requirements of banks, which are calibrated based on historical loss events, may no longer be considered sufficient enough to absorb the losses. Meeting the minimum capital requirement is necessary, but not a sufficient condition for financial stability.

Hence, it is imperative that the approach to risk management in banks should be in tune with the realisation of more frequent, varied and bigger risk events than in the past, he added.

Signs of recovery

The Governor said Indian economy has started showing signs of getting back to normalcy in response to the staggered easing of 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,” he added.

Careful unwinding

Das underscored that the need of the hour is to restore confidence, preserve financial stability, revive growth and recover stronger.

Post-containment of Covid-19, a very careful trajectory has to be followed in orderly unwinding of counter-cyclical regulatory measures and the financial sector should return to normal functioning without relying on the regulatory relaxations as the new norm, he said.

The Reserve Bank is making continuous assessment of the changing trajectory of financial stability risks and upgrading its own supervisory framework to ensure that financial stability is preserved.

According to the Governor, Banks and financial intermediaries have to be ever vigilant and substantially upgrade their capabilities with respect to governance, assurance functions and risk culture.