RBI Governor Shaktikanta Das on Saturday warned that the economic fallout from the COVID-19 pandemic would likely result in an increase in bad loans across banks, and added that a recapitalisation plan was urgently needed to ensure financial stability.
“The economic impact of the pandemic — due to lockdown and anticipated post lockdown compression in economic growth —may result in higher non-performing assets and capital erosion of banks,” Mr. Das said in his keynote address at the 7th SBI Banking & Economics Conclave. “A recapitalisation plan for PSBs and private banks has, therefore, become necessary.”
Observing that the global financial crisis of 2008-09 and the pandemic had dispelled the notion that tail risks to the financial system would materialise only rarely, Mr. Das said, “shocks to the financial system dubbed as ‘once in a lifetime events’ seem to be more frequent than even ‘once in a decade’”. The minimum capital requirements for banks, which had been set based on historical loss events, were accordingly likely to be rendered less than sufficient to absorb lenders’ losses in the current economic climate.
“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 said.
Stating that the economy had started showing signs of getting back to normalcy, the RBI Governor, however, cautioned that “the medium-term outlook is uncertain and depends on the COVID-19 curve”.
“Policy action for the medium-term would require a careful assessment of how the crisis unfolds. Building buffers and raising capital will be crucial not only to ensure credit flow but also to build resilience in the financial system,” Mr. Das said, urging all lenders including non-banking financial institutions to conduct periodic “stress tests” to gauge the impact of the pandemic on their balance sheets, asset quality and liquidity. This, he added, would enable them to take timely action to mitigate the risks.
Pointing to stress points requiring constant regulatory and policy attention, he cited the redemption pressure on NBFCs and mutual funds as a key concern.
“Mutual funds have emerged as major investors in market instruments issued by NBFCs, which is why the development of an adverse feedback loop and the associated systemic risk warrants timely and targeted policy interventions. Increasing share of bank lending to NBFCs and the continuing crunch in market-based financing faced by the NBFCs and Housing Finance Companies also need to be watched carefully,” he added.
Referring to the lack of a mechanism to address bank failures, Mr. Das cited the case of Yes Bank to stress the need for a legislatively mandated Resolution Corporation.
“In the case of Yes Bank we tried for a market-based resolution... when that did not materialise, we, without adversely impacting the balance sheet of any participating bank, worked out a public private partnership.
“But going forward, we need legislative backing to have some kind of Resolution Corporation which has to deal with resolution and revival of stressed financial firms,” he said. While the tradition approach had been to merge the weak bank with a larger bank, he said, “while that protects the depositors’ interest, definitely it pulls down the balance sheet of the large bank”.
A Resolution Corporation was part of the Financial Resolution and Deposit Insurance (FRDI) Bill that the Centre withdrew following depositors’ concerns over a controversial ‘bail-in’ clause.