RBI Governor: Banking System May Be Potentially Exposed To Structural Liquidity Issues; regulatory prescriptions relating to loan to value (LTV) ratio, risk weights and monitoring of end use of funds are not being strictly adhered to by certain entities. I repeat certain entities
FinTech BizNews Service
Mumbai, August 8, 2024: The Monetary Policy Committee (MPC) of the RBI decided on Thursday by a 4 to 2 majority to keep the policy repo rate unchanged at 6.50 per cent.
Liquidity and Financial Market Conditions
System liquidity transited from deficit in June to surplus conditions in July. In tune with the changing liquidity conditions, the Reserve Bank conducted two-way operations under the LAF to ensure that the inter-bank overnight rate remained closely aligned to the policy repo rate.
Shaktikanta Das, Governor, Reserve Bank of India, said while announcing the decisions of the MPC on Thursday: “Going forward, the Reserve Bank will continue to be nimble and flexible in its liquidity management operations keeping in view the evolving liquidity conditions to ensure that money market interest rates evolve in an orderly manner.”
On the demand side, household consumption is supported by a turnaround in rural demand and steady discretionary spending in urban areas. Fixed investment activity remained buoyant, amid government’s continued thrust on capex and other policy support. Private corporate investment is gaining steam on the back of expansion in bank credit. Merchandise exports expanded in June, although at a slower pace. Expansion in non-oil-non-gold imports accelerated reflecting resilience of domestic demand. Services exports recorded double digit growth in May 2024 before moderating in June
Das added: “Looking ahead, improved agricultural activity brightens the prospects of rural consumption, while sustained buoyancy in services activity would support urban consumption. The healthy balance sheets of banks and corporates; thrust on capex by the government; and visible signs of pick up in private investment would drive fixed investment activity. Improving prospects of global trade are expected to aid external demand. The spillovers from protracted geopolitical tensions, volatility in international financial markets and geoeconomic fragmentation, however, pose risks on the downside. Taking all these factors into consideration, real GDP growth for 2024-25 is projected at 7.2 per cent, with Q1 at 7.1 per cent; Q2 at 7.2 per cent; Q3 at 7.3 per cent; and Q4 at 7.2 per cent. Real GDP growth for Q1:2025-26 is projected at 7.2 per cent. The risks are evenly balanced. It may be seen that we have slightly moderated the growth projection for Q1 of the current year in relation to the June 2024 projection. This is primarily due to updated information on certain high frequency indicators which show lower than anticipated corporate profitability, general government expenditure and core industries output.”
Financial Stability
The Indian financial system remains resilient and is gaining strength from broader macroeconomic stability. Its well-capitalised and unclogged balance sheet is reflective of higher risk absorption capacity.
The NBFC sector and the Urban Cooperative Banks also continue to show improvements.
Even in such stable financial sector conditions, the emphasis cannot shift away from proactive identification of potential risks and challenges, if any. In the current context, there are four issues which I would like to highlight. First, it is observed that alternative investment avenues are becoming more attractive to retail customers and banks are facing challenges on the funding front with bank deposits trailing loan growth. As a result, banks are taking greater recourse to short-term non-retail deposits and other instruments of liability to meet the incremental credit demand. This, as I emphasised elsewhere, may potentially expose the banking system to structural liquidity issues. Banks may, therefore, focus more on mobilisation of household financial savings through innovative products and service offerings and by leveraging fully on their vast branch network.
Second, it is observed that the sectors in which pre-emptive regulatory measures were announced by the Reserve Bank in November last year have shown moderation in credit growth.47 However, certain segments of personal loans continue to witness high growth. Excess leverage through retail loans, mostly for consumption purposes, needs careful monitoring from macro-prudential point of view. It calls for careful assessment and calibration of underwriting standards, as may be required, as well as post-sanction monitoring of such loans.
The third issue that is attracting our attention is home equity loans, or top-up housing loans as they are called in India, which have been growing at a brisk pace. Banks and NBFCs have also been offering top-up loans on other collateralised loans like gold loans. It is noticed that the regulatory prescriptions relating to loan to value (LTV) ratio, risk weights and monitoring of end use of funds are not being strictly adhered to by certain entities. I repeat certain entities. Such practices may lead to loaned funds being deployed in unproductive segments or for speculative purposes. Banks and NBFCs would, therefore, be well-advised to review such practices and take remedial action.
Fourth, recently there was an unprecedented IT outage globally, which affected businesses in many countries. The outage demonstrated how a minor technical change, if it goes haywire, can wreak havoc on a global scale. It also showed the fast-growing dependence on big-techs and third-party technology solution providers. In this background, it is necessary that banks and financial institutions build appropriate risk management frameworks in their IT, Cyber security and third-party outsourcing arrangements to maintain operational resilience. The Reserve Bank has time and again emphasised the importance of robust business continuity plans (BCP) to deal with such incidents.
