RBI’s macroeconomic and financial stability measures are worth emulating

It is not clear when RBI will start cutting the Repo rate, most probably around the middle of 2024-25. Core inflation has moderated to a 44-month low of 4.1%. It is a joyful indication that the banking sector has added to resilience of the domestic financial system due to its robust balance sheets with adequate capital, liquidity buffers and strong earnings

The Reserve Bank of India (RBI) has released two important documents this week. ‘Trends & Progress of Banking in India 2022-23’ and ‘The Financial Stability Report December 2023’, can be game changers if properly understood as regards its observations and suggestions vis-à-vis macroeconomic and financial stability perspectives.

As far as global growth is concerned, it would decline to three per cent in 2023 and 2.9% in 2024 as per IMF projection. The world trade growth is projected to fall from 5.1 per cent in 2022 to 0.9% in 2023, a sharp fall that is expected to recover to 3.5 % this year, which will be lower than its average growth rate of 4.9% during 2000-19. Against this, India remains the fastest growing economy in the world and it's real GDP increased by 7.7% in FY 2023-24 and RBI expects India to expand by 7% in FY 2023-24. Some expect the GDP growth to slow down in the second half but still maintain growth at 6.5 % to 6.7%. If the current momentum is further galvanized India should be able to attain 7% growth. The global headwinds like continued geopolitical conflicts and subdued demand as far world trade and volatility in energy prices have some impact on the growth rate. India has so far been able to withstand these factors due to its resilience and domestic demand and favourable policy support backed by RBI’s sound macro stability measures.

The global headline inflation, which has been a major concern in recent years, has started showing moderation and there has been a talk of cut in the reference rate in the coming year.

In India, though the inflation rate declined to 5.6% in November 2023 as against the high of 7.4% in July, which is still much above the RBI mandated target of 4%. Agricultural production being affected due to climate risk and deficit rainfall leading to spike in food prices need to be tamed in order to bring inflation within the target.

It is not clear when RBI will start cutting the Repo rate, most probably around the middle of 2024-25. Core inflation has moderated to a 44-month low of 4.1%.

It is a joyful indication that the banking sector has added to resilience of the domestic financial system due to its robust balance sheets with adequate capital, liquidity buffers and strong earnings.

According to Chart 1.5 Banking Sector Soundness of RBI Financial Stability Report, while advances moved from Rs. 66.9 lakh crore from March 2015 to Rs. 149.2 lakh crore in September 2023, gross NPA came down from 9.6% in March 2017 to 3.2% in September 2023; similarly net NPA from 2.5% in March 2015 went up to 5.5% in March 2017, declined sharply to 0.8% in September 2023; ROA from minus 0.1% in March 2019 currently 1.2%, while the capital adequacy ratio is at a comfortable level of 16.8 % as on September 2023. Banks have made substantial provisions and PCA is at 76.3% as against 41.7% in March 2015. Slippage ratio, which was high at 5.9% in March 2017, has come under control at 1.7%.

With such strong banking sector financial resilience, RBI macro stress tests for credit risk reveal that SCBs would be able to comply with minimum capital requirements, with the system level CRAR in September 2024 projected at 14.8%, 13.5% and 12.2%, respectively, under baseline, medium and stress scenarios. As the RBI Governor in his forward sums up "We have made significant progress since the onset of the COVID-19 pandemic in steering the economy and the financial system. Now is the time to consolidate these gains and enable the economy move to a higher growth trajectory with macroeconomic and financial stability".

The central bank’s guidelines to increase the risk weights for unsecured loans and loans by banks to NBFCS were some of the measures to contain and control large increase in personal lending as well as to reduce the systematic risks with higher interconnectedness between banks and NBFCs. It has asked REs to review their extant sectoral exposure limits for consumer credit and put in place Board-approved limits in respect of various sub-segments under consumer credit. RBI has directed REs not to make investments either directly or indirectly in a debtor company of the RE with a view to address concerns relating to possible ever-greening by them, through AIFs by substitution of their direct loan exposure to borrowers with indirect exposure through investments in units of AIFs.

Banks are to take appropriate risk measures to mitigate climate risk, cyber security risk as RBI Report on FSR in Summary and Outlook in Chapter III Regulatory Initiatives in the Financial Sector mentions, "Ongoing challenges emanating from.cyber Risk and climate related risk are the two major focus areas for policy makers. It further adds that wider adoption of technology in the financial system amidst a new wave of innovations also posted new challenges for financial stability that would require suitable risk mitigating regulatory and supervisory actions."

Regarding NBFCs, the resilience of the non-banking financial companies (NBFCs) sector improved with CRAR at 27.6%, GNPA ratio at 4.6% and return on assets (ROA) at 2.9% in September.

RBI has noticed that during the last four years, the CAGR for personal loans (nearly 33 per cent) has far exceeded the overall credit growth (nearly 15%) for the NBFC sector. This is the reason for RBI’s recent increase in risk weights of select retail loan categories, which could have implications for NBFC credit growth at the overall, sectoral and sub- sector levels.

The country’s financial sector has to be vigilant and proactive in foreseeing and to detect undue risk building up in the system.

Hence, the suggestion in the RBI report, "This has to be supported by prudent management of exposures and building up financial buffers".

RBI Report on ‘Trend s & Progress of Banking in India 2022-23 in Chapter 1 Perspectives’ suggests that sustaining this improvement-the high capital ratios, improved asset quality, robust earnings growth, requires further strengthening of governance, risk management practices and building up additional buffers.

These recommendations of RBI have to be taken in their right perspective by the SCB and NBFCs and other Res. They have to make individual institution stress test, take appropriate actions and improve upon further capital buffers and resilient capabilities by enhancing governance and risk management standards to withstand any future. Being resilient is what they should strive for.

(The author is former Chairman & Managing Director of Indian Overseas Bank)