In our earlier posts, we put forth our comments on the June 2018 and the June 2019 Financial Stability Reports (FSR). These comments pertained to themes such as reforming stress design, disclosing de-anonymised stress test results and providing analysis around the chapter on macro-financial risks. We also highlighted the need for the FSR to have a general sense of continuity and narrative building across the editions. We continue our commentary on the FSR by looking at the latest edition of the report. Our previous commentaries continue to hold.
The FSR published by the Reserve Bank of India (RBI) is a biannual document that aims to present an in-depth analysis of the financial resilience and stability of the global as well as domestic economies. Continuing with a similar structure as the earlier editions, the Dec 2019 FSR presents a discussion on macro-financial risks at both global and domestic levels, soundness and resilience of financial institutions, and regulation and developments in the financial sector. The methodology for testing the resilience of the banking system involves macro-stress tests for credit risk against macro-economic risk scenarios (baseline, medium and severe stress scenarios).
While the FSR does a good job of reporting the projections for various stress scenarios, a lack of continuity and narrative-building continues to impede the reader’s abilities to undertake a thorough interpretation of the report and to do a comparison with previous reports.
The following are our observations regarding the flow and the narrative which would have helped in establishing a more useful analysis and judgement of the FSR.
On Narrative-Building
- As in the June 2019 FSR, the Provision Coverage Ratio (PCR) of Foreign Banks (FBs) is higher than the PCRs of Public Sector Banks (PSBs) and Private Sector Banks (PVBs) even when the Non-performing Assets (NPAs) of PSBs and PVBs exceed those of FBs marginally (Page 26, Chart 2.2 a. and Chart 2.2 d.). As we suggested for the June 2019 FSR, the RBI could have provided more information in this respect, like the proportions of regulatory and proactive provisions.
- The agriculture sector has been in distress over the past few years with the GNPA ratio for the sector recording an increase from 8.5 percent in March 2019 to 10.1 percent in September 2019 (Page 28, Chart 2.3 a.)[1]. The FSR mentions the agricultural distress very briefly and fails to discuss the reasons behind it. Since the stress in agriculture impacts the overall quality of assets in the economy, it would be relevant to talk about it in more detail. Further, even when the slippage ratio for the industrial sector as a whole declined compared to March 2019, few industry sub-sectors like construction, textiles, and rubber and allied products saw a rise in slippages while the service sector also reported a deteriorating GNPA ratio (Page 28, Charts 2.3 a. and c.). There could have been a brief discussion on why these sectors have been facing adversities.
- The Banking Stability Indicator (BSI) showed a sharp improvement across multiple dimensions, especially soundness and profitability (Page 32, Chart 2.5). While it is heartening to see an improvement in the overall system, the RBI can consider delving into the underlying reasons for this improvement. This explanation could also work as a guiding principle for the financial system as a whole.
On Flow/Continuity
- The final section of the FSR talks about the policy measures taken by various institutions like the RBI, PFRDA, SEBI and IRDAI in the past six months (i.e. between the last and current edition of FSRs). To enable a more comprehensive and continuous analysis of how these measures have played out and how the new measures complement the old ones, the RBI could provide a discussion to link back to policy measures showcased as important in previous FSRs.
- Although the December 2019 FSR used the same econometric models for the calculation of slippage ratios as the June 2019 edition, the models demand some explanation about the inclusion or exclusion of the variables used. While calculating the bank-group wise slippage ratios, the model for FBs and PVBs lagged the Exports-to-GDP ratio by 5 years and 1 year respectively, whereas the variable was eliminated altogether for calculating the slippage ratio for PSBs[2]. There are other similar instances of curious variable choices in the models, such as including a dummy variable in the FB model, that need clarification. The model used for macro-level slippage ratio calculations could have included other relevant variables, for example, the Repo Rate for more accurate estimates.
- The RBI has continued to present anonymised results for the stress tests. In order to promote transparency, the Reserve Bank could include details of the banks that fail the stress tests along with the recommended course of actions for them.
- The systemic risk survey and its role in risk assessment remain ambiguous. More details on how the results of the survey are used in analysing and managing risk could be of significant help.
Other Developments
It is customary for the FSR chapter on soundness and resilience of financial institutions to explore different topical themes in each edition of the report. The June 2019 FSR revolved around consumer credit and developments in the NBFC space. In accordance with the point raised in the post on the previous FSR, the RBI this time included a follow up of the June 2019 FSR’s thematic exploration. However, this follow-up only affirms the worsening conditions of NBFCs, specifically the sharp rise in delinquencies and decline in credit growth. Additional analysis could have been undertaken in this area. For example, we see that the share of Commercial Paper (CP) as a borrowing instrument has been significantly reducing for both the NBFCs and HFCs over the last few quarters[3] (Page 52, Chart 2.30). The reduction in the shares of CPs was close to 45% for both NBFCs and HFCs. This is of additional significance considering the entire CP market has been on a downward trend (Page 53, Chart 2.32). Concurrently, long term loans have been taking on an increasing role in the borrowing picture for both NBFCs and HFCs. We may construe this as the market enforcing discipline, after the liquidity crisis, on the NBFC/HFC sector which was earlier engaging in the practice of largely relying on the short-term CPs to fund their long-term assets. The RBI could have addressed such relevant points.
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[1] The agriculture sector has seen steady worsening of its asset quality over the years. The GNPA ratio of the agriculture sector was 5.4% in March 2017. Chart 2.2 d 2017 June FSR.
[2] Multivariate regression equations for bank group level models to estimate the impact of GNPA ratios as part of the macro stress testing done to ascertain the resilience against macroeconomic shocks. Annexure 2, Financial Stability Report, Issue No. 20, RBI.
[3] CP share as a gross payable to the financial system for NBFCs and HFCs reduced from a high of 13.6 percent in Sep 2017 and 19.8 percent in Sep 2018 to a low of the Sep 2019 values of 7.7 and 10.4 percent respectively. Chart 2.41 and Chart 2.42
