Open to look at proposal for setting up bad bank: RBI

The Reserve Bank of India (RBI) is open to looking at any proposal for setting up a bad bank, according to Reserve Bank of India (RBI) Governor Shaktikanta Das.

“A bad bank has been under discussion for a very long time. We have regulatory guidelines for Asset Reconstruction Companies (ARCs). If any proposal (for setting up a bad bank) comes, we are open to examining it and issuing required regulatory guidelines,” Das said in an interaction with participants after delivering the Nani Palkhivala Memorial Lecture.

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Why a ‘bad bank’ may not work well

The Governor emphasised that it is for the government and other private sector players to really plan for the bad bank.

“As far as RBI is concerned, we try to keep our regulatory framework in sync with the requirement of the times. If there is a proposal for setting up a bad bank, RBI will examine and take a view on that,” Das said.

Also read: Bad bank should have been set up 3-4 years back, not now: Kotak Securities report

The Economic Survey 2016-17 had suggested setting up of a centralised Public Sector Asset Rehabilitation Agency (PARA) to take charge of the largest, most difficult cases, and make politically tough decisions to reduce debt. But no steps have been initiated so far to set up PARA.

Later, in 2018, the Sunil Mehta committee had recommended an Asset Management Company-led resolution approach for loans over ₹500 crore. This proposal too, has remained only on paper.

The need to set up a bad bank assumes importance in the context of macro stress tests for credit risks conducted by RBI showing that the gross non-performing asset (GNPA) ratio of Scheduled Commercial Banks (SCBs) may increase from 7.5 per cent in September 2020 to 13.5 per cent by September 2021 under the baseline scenario.

If the macro economic environment deteriorates, the ratio may escalate to 14.8 per cent under the severe stress scenario. These projections are indicative of the possible economic impairment latent in banks’ portfolios, according to RBI’s latest Financial Stability Report (FSR).

In his lecture, the Governor noted that the current Covid-19 pandemic-related shock will place greater pressure on the balance sheets of banks in terms of non-performing assets, leading to erosion of capital.

“Building buffers and raising capital by banks – both in the public and private sectors – will be crucial not only to ensure credit flow but also to build resilience in the financial system. We have advised all banks, large non-deposit taking NBFCs (non-banking finance companies) and all deposit-taking NBFCs to assess the impact of Covid-19 on their balance sheets, asset quality, liquidity, profitability and capital adequacy, and work out possible mitigation measures, including capital planning, capital raising, and contingency liquidity planning, among others,” he said.

Prudently, a few large public sector banks (PSBs) and major private sector banks (PVBs) have already raised capital, and some have plans to raise further resources taking advantage of benign financial conditions. He emphasised that this process needs to be put on the fast track.

Also read: RBI FSR: Bad loans can rise to 13.5% by Septemberas regulatory reliefs are rolled back

Das observed that the integrity and quality of governance are key to good health and robustness of banks and NBFCs.

“Recent events in our rapidly evolving financial landscape have led to increasing scrutiny of the role of promoters, major shareholders and senior management vis-à-vis the role of the Board. The RBI is constantly focussed on strengthening the related regulations and deepening its supervision of financial entities…Some more measures on improving governance in banks and NBFCs are in the pipeline,” he said.

Capital inflows

While abundant capital inflows have been largely driven by accommodative global liquidity conditions and India’s optimistic medium-term growth outlook, domestic financial markets must remain prepared for sudden stops and reversals, should the global risk aversion factors take hold, said Das.

Under uncertain global economic environment, emerging market economies (EMEs) typically remain at the receiving end, he added.

“In order to mitigate global spillovers, they have no recourse but to build their own forex reserve buffers, even though at the cost of being included in the list of currency manipulators or monitoring list of the US Treasury. I feel that this aspect needs greater understanding on both sides, so that EMEs can actively use policy tools to overcome the capital flow-related challenges,” Das said.

The Reserve Bank is closely monitoring both global headwinds and tailwinds while assessing the domestic macro economic situation and its resilience.