'Now Is The Time..': RBI Guv Said Banks, NBFCs Must Continue To Carry Stress Testing Of Their Books

The Reserve Bank Of India's governor Shaktikanta Das highlighted certain key issues which merit the attention of banks, NBFCs, financial sector entities and even businesses during his speech at the FIBAC 2023 Conference. Das guided banks and NBFCs to strengthen their risk management practices and make additional buffers. He said these entities must continue to do stress testing of their books.

During the conference, Das said, "While banks and NBFCs are showing good performance now, sustaining it requires concerted efforts. In good times like these, banks and NBFCs need to reflect and introspect as to where potential risks could originate."

Das believes now is the time for them to further strengthen their risk management practices and build additional buffers to face the situation if the business cycle turns adverse.

On the central bank's part, Das said it has significantly strengthened its regulation and the supervision of banks, NBFCs and other regulated entities in recent years.

He added, "We have also very recently announced a few macro-prudential measures in the overall interest of sustainability. These measures are pre-emptive in nature. They are calibrated and targeted. It may be relevant to note that major growth drivers like loans for housing, vehicles and MSME sector have been excluded from these measures."

Further, he said, "We continue to focus on strengthening governance and assurance functions, ensuring effective risk management and robust lending practices. We are monitoring the supervised entities through various onsite and off-site tools, stress testing, vulnerability assessments, thematic studies, data dump analysis, etc. as part of our proactive and forward-looking supervisory approach."

Accordingly, Das asked banks and NBFCs to continue to be watchful of the stress building in their books.

"Banks, NBFCs and other financial entities must continue to do stress testing of their books," adding he said, "In fact, there is a strong case for companies in the real sector also to stress test their businesses and balance sheets. Many of them may already be doing so, but it would be desirable that many more also do this."

At the current juncture, he said, there may not be any immediate cause for worry, but to remain on top of things, Banks and NBFCs would be well advised to take certain precautionary measures.

In this context, Das explained like to highlighted four points. These are:

- First, while credit growth is accelerating in the current period, banks and NBFCs may take due care to ensure that credit growth at the overall, sectoral and sub-sectoral levels remain sustainable and all forms of exuberance are avoided. Expansion of the credit portfolio itself and pricing of the same should be in sync with the risks envisaged. Banks and NBFCs also need to further strengthen their asset liability management. They may give greater attention to their liabilities side.

Das said, "In certain cases, we have observed increased reliance on high-cost short-term bulk deposits while the tenure of the loans, both in retail and corporate loans, is getting elongated."

- Second, given the increasing importance of non-bank financial companies (NBFCs) in the financial system,7 the increasing interconnectedness between banks and non-banks merits close attention. NBFCs are large net borrowers of funds from the financial system, with their exposure from the banks being the highest. Banks are also one of the key subscribers to the debentures and commercial papers issued by NBFCs. NBFCs also maintain borrowing relationships with multiple banks simultaneously. Needless to say, such concentrated linkages may create a contagion risk. Though the banks are well-capitalised, they must constantly evaluate their exposure to NBFCs and the exposure of individual NBFCs to multiple banks. The NBFCs on their part should focus on broad basing their funding sources and reducing over-dependence on bank funding.

- Third, microfinance has emerged as an important financial conduit to foster financial inclusion. As Micro Finance Institutions (MFIs) are catering to the marginalised clientele, they have to bear in mind the affordability and repayment capacity of the borrowers. Though the interest rates are deregulated, certain NBFCs-MFIs appear to be enjoying relatively higher net interest margins. It is indeed for microfinance lenders to ensure that the flexibility provided to them in setting interest rates is used judiciously. They are expected to ensure that interest rates are transparent and not usurious.

- Fourth, the increased collaboration of Banks and NBFCs with FinTechs is facilitating the introduction of innovative products and services and new business models. Digital technologies are offering a powerful medium to access banking and financial services. This has also brought down operational costs and helped in enhancing the reach of financial services providers. An important aspect that merits attention in this context is model-based lending through analytics. Banks and NBFCs need to be careful in relying solely on pre-set algorithms as assumptions based on which the models are operated. These models should be robust and tested and re-tested periodically. They may require to be calibrated and re-calibrated from time to time based on the changing contours of the financial ecosystem and fresh information. It is necessary to be watchful of any undue risk build-up in the system due to information gaps in these models, which may cause dilution of underwriting standards.

In his concluding remarks, Das said, "We are living in highly uncertain times in an interconnected world. New risks are emerging from time to time. New sources of risk are also coming up. In such a scenario, building up further on resilience would be the best insurance against shocks and uncertainties. This holds good for all businesses and financial entities."