Financial Stability Report 2021 Analysis | UPSC

• As we approach the Union Budget for 2021-22 there is a natural curiosity about the current state of the Indian economy.
• A couple of weeks ago we explained the key takeaways from the latest GDP estimates released by India’s central government.
• Last week saw another important report — the Financial Stability Report (FSR), which was released by the Reserve Bank of India (RBI).

FINANCIAL STABILITY REPORT 2021

• The FSR is a hugely useful publication as it receives contributions from all the financial sector regulators in the country.
• As such, it provides a rather comprehensive picture of the so-called macro-financial risks facing the economy.

• They are difficult to define but, much like obscenity, you know them when you see them.
• For instance, if lots of banks in an economy find that the loans they extended to different businesses are unlikely to be repaid, it is a macro-financial risk.

CONSEQUENCES

• If banks do not get their money back, they won’t be able to fund the next set of investments.
• Even if the government decides to use the taxpayer’s money to bail them out, it will have to curtail some other expenditure — perhaps on education or healthcare or infrastructure.
• So, one thing can lead to another and the economic growth of a country can take a massive hit just because too many banks had too many non-performing assets (NPAs or bad loans) all at the same time.

• That is what we mean when we say that macro-financial risks are systemic in nature.
• It is for this very reason, prevention is better than cure. The FSR released by the RBI is the biannual alert of such risks in the Indian economy.

KEY POINTS

• According to the RBI’s analysis, the level of NPAs in India’s banking system could almost double between September 2020 and September 2021.
• (The Scheduled Commercial Banks’) SCBs’ GNPA (gross NPA) ratio may increase from 7.5 per cent (of all loans extended) in September 2020 to 13.5 per cent by September 2021 under the baseline scenario.
• If the macroeconomic environment deteriorates, the ratio may escalate to 14.8 per cent under the severe stress scenario.
• To see these percentages in perspective, one must note that when the economy was growing fast — before the 2008 financial crisis — NPAs hovered around the 2.5 per cent level.

SOURCES : IE

• The “stress tests” done by regulators also indicate that in the severe stress scenario several banks may fall short of sufficient capital (money) to meet the regulatory benchmarks.

CONCERNS

• High bank NPAs are not the only thing RBI is worried about.
• Meanwhile, the disconnect between certain segments of financial markets and the real economy has been accentuating in recent times, both globally and in India.
• Stretched valuations of financial assets pose risks to financial stability.
• Banks and financial intermediaries need to be cognisant of these risks and spillovers in an interconnected financial system.
• In simple terms, RBI is worried that the measures — such as increased availability of money and that too at low-interest rates as well as the fiscal stimulus will trouble on a longer run.

• Support measures may have unintended consequences as reflected, for instance, in the soaring equity valuations disconnected from economic performance.
• These deviations from fundamentals, if they persist, pose risks to financial stability, especially if recovery is delayed.
• It is a fact that stock market indices, both in India and elsewhere, have surged even when the real economy — that is the number of cars/TVs/ACs/ phones/ houses/ travel trips etc. — has struggled in contrast.
• Easy money often creates asset bubbles, which when they burst tend to bring down the real economy.

SOURCES : IE |  Major impediments to a robust economic recovery post COVID-19

• What makes these shocks worse is the level of interconnectedness among financial institutions.

• Their gross receivables were Rs 7.74 lakh crore.
• The top recipients of their funding are banks, followed by NBFCs, HFCs (housing finance companies) and AIFIs (All India Financial Institutions such as NABARD, EXIM, NHB and SIDBI).
• Given the interconnectedness among them, a sell-offs can potentially transmit asset market shocks across the financial system.