The Reserve Bank of India (RBI) Governor recently sounded an alarm regarding the impending economic effects of the Covid-19 pandemic. The prediction is that it might result in an increase in Non-Performing Assets (NPAs) and cause a significant decline in the capital of banks.
Economic Impact of the Covid-19 Pandemic and Global Financial Crisis
In just a decade, the Indian economy has been hammered by two major global crises. The first was the global financial crisis of 2008-09, followed by the current Covid-19 pandemic. The settlement of the latter crisis, however, may leave more prolonged impacts on the Indian economy. There is a projection that there will be a contraction in the Indian economy in the Financial Year (FY) 2020-21, marking the first such happening over the past four decades.
Uncertain Future Economic Conditions
The uncertainty surrounding the full restoration of supply chains, as well as the normalisation of demand conditions, poses significant challenges to the economy’s recovery process. More so, there are concerns about the long-term impact of the pandemic on India’s potential growth.
Issues Plaguing the Banking Sector
The banking sector is currently grappling with a series of issues, including poor asset quality, loss of profitability, capital depletion, excessive risk exposure, improper conduct, and liquidity concerns. There is also an absence of an effective mechanism to deal with bank failures. Besides, non-banking financial companies (NBFCs) and mutual funds have emerged as critical stress points in the financial system.
Suggested Mitigating Measures
The RBI Governor has urged all financial intermediaries to critically evaluate the impacts of Covid-19 on their balance sheet, asset quality, liquidity, profitability, and capital adequacy for FY 2020-21. They should also develop possible measures to counter these effects.
The objective is to ensure the continual supply of credit to different sectors of the economy and uphold financial stability. Financial intermediaries must adjust their risk management strategies to align with the emerging contingencies.
Strengthening Internal Defences of Banks
Risk management should encompass building buffers and raising capital. This approach will help reinforce the banks’ internal defences against the risks posed by Covid-19, and ensure a consistent flow of credit.
There are plans to recapitalise both public and private sector banks, given that the minimum capital requirements might no longer be adequate to cover potential losses. These minimum capital requirements for banks have been set based on historical loss events.