The Reserve Bank of India recently identified certain gaps in the risk management systems and accordingly levied penalties and imposed operational restrictions on certain regulated entities (REs).

Sensing the build-up of credit risks in infrastructure finance, the RBI proposed to increase the provisioning of project finance to 5 per cent, up from 0.4 per cent in a calibrated sequence — 2 per cent effective March 31, 2025, 3.5 per cent by March 2026, and 5 per cent by March 31, 2027.

Banks can effectively manage credit and liquidity risks by collaborating with NaBFID which can fund larger infrastructure projects for longer duration. Banks can reduce their exposure to long-term lending keeping the limitation of duration of their liabilities.

The RBI further felt the need to review regulations on gold loans based on the risky lending practices in IIFL Finance. The RBI is keen to review the norms related to loan to value (LTV), cash disbursements, assaying of gold, auctioning system of gold, etc., which are operational parts of credit administration.

In November 2023, the risk weights were increased on certain kinds of unsecured personal loans — consumer loans, bank loans to NBFCs, credit cards, etc., where the RBI perceived concentration of higher credit risk.

REs should have managed their sectoral exposure based on internal credit risk assessment systems linked to their risk appetite. Instead, the RBI had to identify the rising credit risk, prompting REs to cap exposure by raising risk weights.

Some impact on sectoral credit deployment could be seen during FY24. Personal loans grew 17.7 per cent during FY24, down from 21 per cent a year ago, of which growth of credit card outstandings moderated to 25.6 per cent, down from 32.5 per cent.

It is noteworthy that banks have built strong balance sheets during FY24 and could post a combined profit for the first time exceeding ₹3-lakh crore. GNPAs are close to 3 per cent and net NPAs in many banks are under one per cent. The provision-coverage ratio is close to 90 per cent. The capital adequacy ratio (CAR) was 16 per cent in December 2023.

Proactive tightening of credit risk management may be an apparent measure to prevent any ‘irrational exuberance’ in lending as during 2007-12, once the demand for corporate credit increases with a fall in interest rates.

Credit expansion to infrastructure and project finance was a key factor leading to a twin balance sheet crisis calling for an asset quality review by the RBI in September 2018. It peaked GNPAs to a high of 11.5 per cent by March 2018 prompting the RBI to invoke the prompt corrective action (PCA) framework against many banks.

Micro-prudential norms

It is the responsibility of individual REs to set their micro-prudential norms to effectively manage business risks based on their level of exposure, risks and regulatory gaps, if any.

REs should also take a cue from the recent RBI action against Paytm Payments Bank, Kotak Mahindra Bank, IIFL, and JM Financials in 2024 and test their internal risk management systems.

Among the range of financial sector risks, besides credit risk, operational risk management could be more daunting looking at the increasing role of technology and the need for employees to acquire new skill sets and competencies. The RBI issued a new guidance note on operational risk on April 30 and extended it to all REs instead of only banks.

In the larger interest of sustainability and financial stability, the government expects banks to focus on core business and not be exposed to liquidity risks by lending long and borrowing short. REs should continuously identify gaps in integrated risk management systems to improve the standard of corporate governance.

The writer is an Adjunct Professor, at the Institute of Insurance and Risk Management. Views are personal

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