In the recent news, the Reserve Bank of India (RBI) has issued its Financial Stability Report (FSR) for July 2020. This report is significant as it provides a comprehensive evaluation of the financial stability and robustness in the country, done by the Sub-Committee of the Financial Stability and Development Council (FSDC), that’s led by the Governor of RBI. Moreover, it also discusses important matters related to the financial sector development and regulation.
The rise in Non-performing Assets
The FSR has highlighted increasing concerns over Gross Non-performing Assets (GNPA). According to the RBI, the GNPA ratio of all Scheduled Commercial Banks (SCBs) could surge from 8.5% in March 2020 to around 12.5% by March 2021. The situation could further deteriorate, with the GNPA ratio possibly hitting 14.7% by the end of this financial year, if the economic impact of Covid-19 exacerbates.
Experts have predicted that if the Covid-19 crisis continues to pervade the economy, about 5% of loans under moratorium could potentially become NPA. On account of the pandemic, the RBI had issued a six-month loan moratorium for all term loans initially from March-May 2020, extended later to June-August 2020. The lockdown induced by Covid-19 adversely affected industries and resulted in substantial income loss, impacting their loan repayment capacity which may cause the GDP to contract by 8.9% in 2020-21.
The Decline in Capital Adequacy Ratio (CAR)
The RBI has projected a fall in the Capital Adequacy Ratio (CAR), which can slump to 13.3% in March 2021 under the normal scenario and to 11.8% under an extremely stressful scenario. The CAR is an important metric of a bank’s financial health, indicating the ratio of its capital to its risk-weighted assets and current liabilities. The Indian SCBs are required to maintain a minimum CAR of 9%. There was already a decrease in CAR from 15% in September 2019 to 14.8% in March 2020.
Increased Risk Aversion among Banks
Risk aversion is growing among Public Sector Banks (PSBs) when compared to private banks, with PSBs preferring to loan money only to high-quality borrowers. However, this risk-aversive tendency is gradually becoming prevalent among private banks as well. The RBI has issued a warning stating that extreme risk aversion might negatively impact the economy.
Financial System Stability amidst Risks
Despite certain risks, the RBI assured that the Indian financial system remains stable. Risks to short term economic prospects due to lockdown-induced disruptions, reduced consumer confidence and risk aversion, could be significant.
Issues and Challenges
Former RBI Governor Urjit Patel expressed criticism over the government’s decision to dilute the Insolvency and Bankruptcy Code (IBC) and the powers of the RBI. He stated that it undermined the efforts made since 2014 to clean up the bad loan issue.
Suggestions for Improvement
Financial intermediaries need to evaluate the effects of Covid-19 on their balance sheets, asset quality, liquidity, profitability, and capital adequacy for the financial year 2020-21 and develop potential mitigating measures. Risk management should be made in sync with emerging contingencies. This includes building buffers and raising capital, which will strengthen the internal defences of banks against the risks posed by Covid-19 and also ensure a steady flow of credit. A recapitalisation plan for Public Sector Banks (PSBs) and private banks is also suggested since the minimum capital requirements of banks may no longer be sufficient enough to absorb the losses.
