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RBI’S FINANCIAL STABILITY REPORT JULY 2021
Read more on - Polity | Economy | Schemes | S&T | Environment
- The story: The Reserve Bank of India has released its July '21 version of the Financial Stability Report (FSR), where it looks at questions like do Indian banks (both public and private) have enough capital to run their operations, or are the levels of bad loans (or non-performing assets) within manageable limits or are different sectors of the economy able to get credit (or new loans) for economic activity such as starting a new business or buying a new house or car?
- Macro perspective: The RBI in its FSR has put together data and information allowing it to assess the state of the domestic economy, especially in a fast-changing global economy. It also assesses the macro-financial risks, which refer to risks originating from the financial system but affecting the wider economy and risks to the financial system that originate in the wider economy.
- Example - If a high percentage of loans extended by banks in the past turn “bad” (not being repaid) perhaps because of a lockdown or fall in demand for certain goods and services, then such banks will be unable to extend new loans to the wider economy because of reducing profitability; so a bad loans problem turns into a growth issue for entire Indian economy.
- The RBI tries to explain how a shock in one part of the financial system affects another part; so how would Banks' poor position affect companies that finance housing loans.
- Stress testing: As part of the FSR, the RBI conducts “stress tests” to find what may happen to the health of the banking system if the broader economy worsens. It tries to assess how factors outside India — crude oil prices or interest rates in other countries — may affect the domestic economy.
- Systemic Risk Surveys (SRS): Each FSR also contains the results of the 'Systemic Risk Surveys'. In 2020, as India was battling the first Covid wave, the RBI was worried about bad loans shooting through the roof. According to the FSR in June 2020, depending on the level of stress in the economy, Gross NPAs could rise from 8.5% (of gross loans and advances) at the end of March 2020 to a two-decade high of as much 14.7% by March 2021.
- By June 2021, the FSR found that the actual level of bad loans as of March 2021 was just 7.5%. But it says that “macro-stress tests” for credit risk show that the GNPA ratio of Scheduled Commercial Banks (SCBs) “may rise from 7.48 per cent in March 2021 to 9.80 per cent by March 2022 under the baseline scenario and to 11.22 per cent under a severe stress scenario”.
- So while the relief provided by the RBI in 2020 — cheap credit, moratoriums and facilities to restructure existing loans — has limited the number of firms that defaulted on loan repayments, things could yet get worse, especially for the small firms (or MSMEs).
- It depends on factors like the evolution of the virus (and its impact on the economy) as well as the decision of central banks the world over to raise interest rates (to manage rising inflation) and wind up their cheap money policy.
- As Governor Shaktikanta Das says: a clear picture of NPAs will emerge only when the regulatory relief provided by the RBI is taken away.
- RBI's trouble: The FSR explains the problem: “Historical experience shows that credit losses remain elevated for several years after recessions end. Indeed, in EMEs [Emerging Market Economies], non-performing assets typically peak six to eight quarters after the onset of a severe recession. Eventually, support measures will be phased out. The longer that blanket support is continued, the higher the risk that it props up persistently unprofitable firms (‘zombies’), with adverse consequences for future economic growth”. So, providing excess regulatory relief might just help firms that don't deserve to get it because they are inefficient, and helping out inefficient firms is a burden on the taxpayers of the country.
- Do it too quickly and ... : If support measures are phased out before firms’ cash flows recover, the banks will have to increase provisions and might tighten lending standards to preserve capital which can undermine recovery. Banks need sufficient buffers to absorb losses along the entire path to full recovery. Beyond the NPAs, the latest FSR provides some key pointers to the state of the economy.
- Learnings from credit growth data: The rate of credit growth in commercial banks shows that - (i) at less than 6%, the overall rate of credit growth is poor, and the low growth rate in wholesale credit (loans worth Rs 5 crore or more) is visible (growth rate for retail loans (loans to individuals including housing loans, loans for the purchase of durables, auto loans, credit cards and educational loans) are doing better, (ii) the sharp fall in credit growth happened much before the Covid pandemic hit India, suggesting that recovery in credit growth may take longer than usual.
- SRS: The FSR published results of the latest round (April 2021) of the Systemic Risk Survey (SRS), that try to capture the perceptions of experts on the major risks faced by the Indian financial system. The risks are classified into five categories - global, macroeconomic, financial market, institutional and general. The overall risk perception is “medium”, but several factors have elicited more negative response (than the Jan FSR) perhaps as surveys were in April. A large percentage of respondents expected employment, productivity, and wages to decline, even as they expected prices to rise.
- Summary: Not everyone or every sector will recover at the same pace. Experts expect a K-shaped recovery from the second Covid wave. It is noteworthy that only 8% expected a “V-shaped” recovery.
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