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While the banking sector has shown signs of stabilisation, the performance of public sector banks (PSBs) needs to improve and they need efforts to build buffers against disproportionate operational risk losses, according to Reserve Bank of India Governor Shaktikanta Das.
In his foreword to the latest Financial Stability Report (FSR), the Governor said the private sector banking space also needs to focus on aspects of corporate governance.
“Financial sector regulators under the aegis of the Financial Stability and Development Council (FSDC) are striving to buttress the trust in the financial system.
“Having said that, let me re-emphasise the importance of good corporate governance across the board, which to my mind is the most significant factor that can lift the efficiency of our economy to its full potential,” the Governor said.
Das noted that as the world continues to grapple with uncertainties of various hues, higher expectations from monetary policy as a panacea for all economic problems also persist.
Extraordinary monetary policy stimulus has driven global interest rates lower to ‘never-seen-before’ levels in some Advanced Economies and a significant pool of these resources is also chasing emerging market assets with consequent impact on the asset prices and corporate leverage, even as emerging market growth and corporate earnings outlook remains weak, he added.
Das underscored that: “The challenge is to ensure transmission of monetary policy impulses to the advantage of real economies and not to aid build-up of froth in financial markets. We need to be mindful of the ‘cobra effect’.”
When an attempted solution makes the problem worse, it is called the ‘cobra effect’.
GNPAs may rise
As per the FSR, macro-stress tests for credit risk show that under the baseline scenario, scheduled commercial banks’ (SCBs) gross non-performing assets (GNPA) ratio may increase from 9.3 per cent in September 2019 to 9.9 per cent by September 2020. This is primarily due to change in the macroeconomic scenario, marginal increase in slippages and the denominator effect of declining credit growth.
The report said India’s financial system remains stable notwithstanding weakening domestic growth.
Caution on solvency shock
Pointing out that non-banking finance companies (NBFCs) and housing finance companies (HFCs) are the largest and the second largest borrowers of funds from the financial system, with a substantial part of this funding coming from banks, the report cautioned that failure of any NBFC or HFC will act as a solvency shock to its lenders.
The solvency losses caused by these shocks can further spread by contagion either due to direct linkages among the lenders or due to an information contagion, it added.
Referring to the banking stability indicator, the report said this shows that there was an improvement in the banking sector’s soundness, profitability, efficiency and liquidity in September 2019 as compared to March 2019.
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