Banks, financial institutions should proactively undertake stress testing of loan books: RBI Deputy Governor Rajeshwar Rao

Despite the improvement in asset quality, financial institutions, including banks, need to proactively undertake stress testing of loan books to examine their loss absorption limits and take steps to improve them wherever required, RBI Deputy Governor M Rajeshwar Rao said on Thursday.

The gross non-performing assets (GNPAs) and net NPAs of banks improved to 5.97 per cent and 1.7 per cent as of March 31, 2022, from 9.23 per cent and 3.66 per cent as of September 2019, respectively, he said.

Although the asset quality has improved from the pre-pandemic levels, lenders should ascertain whether this is on account of better fundamentals or due to the regulatory support extended to deal with the impact of the pandemic, he noted.

"We expect banks and other financial institutions to proactively undertake stress testing of their loan books, subjecting them to various levels of stress, including extreme scenarios, to estimate the loss absorption limits wherever available at their disposal, and take measures to augment the same wherever necessary," Rao said at an event organised by IMC Chamber of Commerce and Industry.

He said while the central bank has attempted to combat the impact of the pandemic on the financial system, (but) the task is only half done. "We have to ensure that the financial system escapes unscathed as we exit from the pandemic-driven regulatory forbearances," Rao said.

Rao said the pandemic saw the financial sector enjoying favourable momentum with an increase in liquidity, the flow of credit and normal spending on relief programmes. "It is getting increasingly debated in the global fora as to whether the pandemic-induced measures have led to a build-up of leverage and debt overhang in the non-financial sector.

"Prudence has to be exhibited by banks to ascertain whether the current levels of asset quality being exhibited is on account of improvement in fundamentals of business on account of deleveraging and efficiency gains or on account of support extended by authorities through the measures, the deputy governor noted. He said the RBI will soon issue a discussion paper on the introduction of a framework on expected credit loss models for banks.