Banks need to proactively undertake stress testing of loan book, says RBI deputy governor

RBI

A preliminary assessment of the banking sector looks encouraging but lenders and financial institutions must proactively undertake stress tests to strengthen assets and identify credit risks, a deputy governor of the central bank said.

“We expect banks and other financial institutions to proactively undertake stress testing of their loan books, subjecting them to various levels of stress and look at extreme situations,” M Rajeshwar Rao added at an event.

Banks must exhibit prudence in asserting whether the current levels of asset quality is on account of improvement in fundamentals, like deleveraging and capital gains, or on account of support from fiscal and monetary authorities, he said.

Indian banks are just about recovering from the pandemic and lockdowns that shrivelled borrowers’ income. A combination of measures by the Reserve Bank of India and credit guarantee schemes by the government helped borrowers and banks throughout the pandemic. Banks made adequate provisions and raised capital to cushion their balance sheets.

Rao said today that most banks are in a comfortable capital position which should help them in supporting economic recovery. Fresh slippages have also been brought under control, he added.

The asset quality at the banks has improved and the gross and net non-performing asset levels have improved from pre-pandemic levels.

He elaborated that gross and net non-performing ratios (NPA) that were 9.23 and 3.66 percent respectively in September 2019 came down to 5.97 and 1.7 percent in March 2022.

Going forward, the RBI is looking to align a prudential framework of banks with global standards, Rao said. The central bank is also contemplating releasing guidelines on digital lending and climate financing, he added.

Another issue grabbing RBI’s attention is the framework for provisioning loan loss exposures, the deputy governor said.

Currently, banks operating in India are required to make loan loss provisions under the incurred loss model wherein the provisions are made after the occurrence of default.

“However, loan default itself is an outcome of a build-up of stress. Thus, an incurred loss approach may be insufficient and could impact the health of banks as well as that of the financial system,” Rao said

There is a need for an expected credit loss model wherein stress will be recognised at an early stage. RBI is in process to issue a discussion paper on expected credit loss for banks, he added.