Dear Reader,
Ever tried to hear the sound of raindrops during a storm? It is hard because it is drowned by the thunder of the storm. But on a simple rainy day, the sound is pleasant, even comforting. Financial stability is like the sound of raindrops, giving comfort to all the stakeholders involved, especially the regulators.
The Reserve Bank of India details this comfort in its latest financial stability report by highlighting the strength of the financial system it oversees, along with other regulators. At the heart of this are banks that have delivered one of the best performances in recent years, showing off robust growth metrics as well as enviable profitability. Banks are the bedrock of financial stability in India and the RBI is pleased to reiterate their balance sheet heft and impeccable risk profile in the report. Our Chart of the Day here captures this exemplary page on banks. India’s lenders have fortified their capital ratios, their bad loan pile is at a multi-year low and return ratios are at decadal high. What’s more, banks have enough dry powder to sustain these impeccable metrics for one more year at the least.
The RBI has every right to feel good about its own proactive measures that have resulted in not just a robust banking system but also an improved non-bank financial ecosystem. Granted, there are areas of concern surrounding the fintechs and retail credit, but these stress points are also quite mild, according to the RBI.
But the RBI would be remiss if it did not include potential warnings that could jeopardise financial stability and challenges that must be monitored.
As our piece here details, the central bank has lauded its financial institutions, but it is still circumspect when it comes to capital markets. In the financial stability report, the RBI flags the challenges a red-hot derivatives market poses for India. Indeed, the equity futures and options market is many times bigger than the cash segment and retail investors are getting carried away by notional profits ballooned simply by a bullish market. The Securities and Exchange Board of India (SEBI) entrusted with capital markets regulation has been working double time to plug the holes in existing rules and update regulation to cover newer areas such as technology, private credit and alternative investments. But markets being markets, ways to sidestep rules are figured out even before rules are laid out.
SEBI chief Madhabi Puri Buch laid out a series of measures at the press conference following the board meet yesterday that included tightening rules for finfluencers, tweaks in rules for alternative investment funds and a framework for cyber security. Importantly, Buch said the regulator is open to taking some derivatives products off the market. All this comes even as regulators are firefighting malfeasance such as front-running of which Quant Mutual fund is accused of by the regulator. Ananya Roy’s column on what this means for investors is a must read.
Misgivings in capital markets spook foreign investors, but geopolitics is a bigger put-off. Foreign money flow into Indian equity and debt markets has been on an upswing, a key reason behind the bullish narrative surrounding the markets. While we may argue (and the RBI has too) that the optimism from foreign investors is because of the Indian economy’s resilience, the heft of the economy is always put to test by changing geopolitical winds.
The stability report cites an RBI staff study highlighting that foreign portfolio inflows have been low during months of geopolitical uncertainty. Two wars, and the complicated relationship between the stakeholders involving the US, the Middle East, Europe and China have made investors question the merit in sticking with emerging markets such as India all the time.
The inclusion of Indian bonds in global bond indices may add a feather in India’s bullish sentiment cap, but it does not safeguard against a global shock and resulting spillovers. The RBI’s report doesn’t mince words when it says, “global spillovers remain a key near term vulnerability”.
That brings us to two completely different challenge for policymakers: technology and climate change. By their very nature, these risks are not within the RBI's control -- at best, the central bank can build guardrails around the financial system to withstand any adverse impact. It is handling the technological challenges by pushing financial firms it regulates to beef up their systems, and even penalising them if they fail. Recall the partial business restrictions imposed on HDFC Bank, Bajaj Finance, Federal Bank and Kotak Mahindra Bank linked to their digital operations.
Climate change is a joker in the pack and central banks across the world are yet to fully develop a framework for the same. The northern parts of India have just emerged out of a punishing heatwave, staring at a water crisis while the monsoon season is falling short of expectations. This FT editorial take on rising temperatures around the globe highlights why weather events are catastrophic for some economies. For India, a clear loss of productivity and output has been estimated.
Climate change is quite literally the storm that could shake India’s economic aspirations. A more urgent storm is the fallout of geopolitics onto capital flows. Every storm begins with raindrops. As Hyman Minsky warned, the seeds of instability are sown during prolonged stable periods. The RBI must look out for them to be ready for the next crisis.
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Aparna Iyer
Moneycontrol Pro
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