Financial Stability Report: Halfway house

The latest edition of RBI’s Financial Stability Report (FSR) was much awaited for answers to some of the burning questions relating to the non-bank crisis simmering in India’s debt markets. This is especially so after the June edition of the monetary policy review passed without any material comment from either the RBI or the Monetary Policy Committee on this issue. The report takes an analytical deep-dive into the asset-liability profiles of non-banking finance companies (NBFCs) and housing finance companies (HFCs) to reveal the anatomy of the crisis. But it stops short of offering, or even debating, possible solutions to it.

The FSR has good news to impart on domestic banks, concluding that their legacy NPAs peaked out in March 2018 and are now set to steadily diminish. The bulk of these NPAs are now accounted for, with the provision coverage at 60 per cent. The improvement in banks’ aggregate capital adequacy ratio to 14.3 per cent with a shrinkage in the number of precarious PSBs, should have the Centre heaving a sigh of relief. But the section devoted to the non-bank sector raises more questions than it answers. For instance, noting that market borrowings via debentures have been drying up for NBFCs/HFCs, it finds that banks are now larger funders of NBFCs. However, the report also observes that 80 per cent of bank exposures to NBFCs are concentrated in the top 30 names, begging a question on how the remaining 9,600-odd non-banks are meeting their liquidity needs. Presenting granular data on delinquencies in loans given out by banks vis-a-vis NBFCs/HFCs, it concludes that NBFCs have an ‘adverse selection’ bias. But the fact that NBFCs lend to riskier segments of borrowers is already well-known. The question now is whether their risk management practices are robust enough to ward off solvency risks. The FSR’s stress-tests lead to the finding that the failure of a beleaguered HFC or NBFC can dent the Tier 1 capital of the entire banking system, while possibly triggering one or two bank failures. But after presenting this alarming conclusion, it refrains from either naming the precariously placed HFCs/NBFCs or discussing a resolution plan.

Overall, while the report does a thorough job of diagnosing the weak spots lurking in the financial system, it disappoints by not suggesting cures. The tone of the report also gives the impression that the RBI, at this juncture, given its dual roles as the regulator of non-banks and the custodian of financial sector stability, is torn between taking a critical view of its constituents and soothing the market’s frayed nerves. The collapse of the systematically important IL&FS and yawning asset-liability mismatches at HFCs also call for introspection on the part of the RBI on how its own supervisory failures contributed to this crisis. It would have been good if the FSR had dwelt on this aspect as well.

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