RBI sees rising risk factors and hints at strong counter measures to tackle bad assets

The RBI has warned that the economic environment in near future is going to be a high risk scenario. In its update of the Financial Stability Report, the RBI has highlighted both external and domestic environment are pushing the economy to a phase of concern.

The Financial Stability Report is addressing the financial stability risk for the economy and provides an objective assessment of the financial sector risks ever since it was first published in March 2010.  

On the external front, the central bank brings two risk factors in incubation. First is the monetary policy reversal policies to be adopted in US and other advanced countries. The spillovers from the quantitative easing reversal may cause liquidity stress in emerging and developing markets.

Second risk factor is the Greek debt crisis. The possibility of a default may trigger financial market volatility in India.

NPAs in the banking system

The RBI is conducting stress tests to assess the asset quality and capital position of banks individually and systemically. As per the present assessment, the RBI observes that the Public Sector Bank’s Non Performing Assets or NPAs continues to remain at higher levels. For the banking system, these ‘stressed assets’ (NPAs) are yet to come down. The situation is particularly serious for Public Sector Banks.

But the capital to risk weighted assets ratio (CRAR) of SCBs, at system level, was observed to remain above the regulatory minimum even under adverse macro-economic conditions.

The RBI’s report is to be noted about the possibility of high dose medicine for the present level of bad assets. Adding to the risk scenario and the assertion that capital requirements are in the sufficient levels, the RBI hints that PSBs may have to undertake strong provisioning norms to cover the risk.

“PSBs may have to bolster their provisions for credit risk from present levels, to meet the ‘expected losses’ if macroeconomic environment were to deteriorate under assumed stress scenarios.”

Meaning of the prescription is that the provisioning coverage ratio or the money that the banks have to set aside (usually from profits) is going to be high. This in turn may affect the share prices of the banks and dividend returns as well.