RBI’s Financial Stability Report (FSR) and Report on Trends and Progress of Banking in India were unanimous about strengthening the banking and financial system. RBI also flagged incipient risks building up in the financial sector which could eventually disrupt its stability and growth.

Given the rise in unsecured personal loans, consumer loans, credit card receivables, and NBFCs, RBI had already increased their risk weights. There is an increasing interconnectedness between banks and non-banks in sharing businesses and risks despite their diverse risk management practices.

Though the regulatory arbitrage between banks and non-banks is reducing fast with stringent regulations, banks may be exposed to some risks when they collaboratively carry out banking operations.

In this milieu, the RBI expects individual regulated entities (REs) to take cognisance of any such latent risks building up in the composition of assets and liabilities and should put appropriate risk controls by reining in exposure. With differentiated business priorities and objectives, REs may tend to diversify into businesses for which the connected entity is not fully geared to manage its risks. Instead of focusing only on business volume, its risks have to be considered in building balance sheets.

Performance of banks

Thanks to the quick post-Covid bounce-back, bank balance sheets of banks grew by 12.2 per cent, a nine-year high. The capital-to-risk-weighted assets ratio (CRAR) at 16.8 per cent at the end of September 2023 as against a minimum of 11.5 per cent is commendable. This provides a lot of legroom for banks to increase their CRAR.

The gross non-performing assets (GNPA) ratio went down to a decade-low of 3.2 per cent at the end of Q2 of FY24. The most significant performance indicator is the rise in net profits from ₹1.82 trillion in FY22 to ₹2.63 trillion even when the liquidity costs went up.

The higher lending rates and lower provisioning needs have contributed to the uptick. Despite this commendable performance, there are fears of risks escaping the controls of REs.

Missing risks

The business model of REs moulds the mix of assets and liabilities of the balance sheet. The increasing size of the balance sheet in line with the corporate objectives is welcome but the magnitude of its inherent risks may not be fully discernible. The REs should be able to measure risks and manage them effectively as business grows.

The internal capital adequacy assessment policy (ICAAP) to a large extent ensures that risk exposures are kept within the limits set by the REs. Since the businesses and risks are better known to REs, the balance sheet built up and its composite risks have to be precisely planned. The sectoral stock-taking of risks of the balance sheet cannot be sporadic.

While the regulatory guidelines will be common to the industry, the shape of balance sheet and its inherent risks will be diverse. Hence, the internal risk governance of REs should be such that sectoral exposure and risks get monitored regularly. Right sizing balance sheet risks should be considered more important than targeting business volumes that could possibly carry higher risks.

Developing a culture of informed risk taking at the grassroots level will be necessary. REs can have freedom to choose their lines of business and business model so long as the regulator is confident of risk management systems that could be vouched during onsite surveillance.

The writer is Adjunct Professor, Institute of Insurance and Risk Management – IIRM. Views expressed are personal

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