MC Explains: Will companies take up RBI’s suggestion on stress testing?

Reserve Bank of India

Reserve Bank of India (RBI) governor Shaktikanta Das said that banks, non-banking financial companies and other financial entities must continue to test their books to identify early signs of stress.

Das also pitched stress testing for real estate companies.

"There is a strong case for companies in the real sector to stress test their businesses and balance sheets. Many of them may already be doing so, but it would be desirable that many more also do this," Das said on November 22 at a banking event in Mumbai organised by the Federation of Indian Chambers of Commerce and Industry and the Indian Banks Association.

He said the RBI will continue to focus on strengthening governance and assurance functions, ensuring effective risk management and robust lending practices.

"We are monitoring the supervised entities through various onsite and off-site tools, stress testing, vulnerability assessments, thematic studies, data dump analysis, etc. as part of our proactive and forward-looking supervisory approach," he added.

Stress testing refers to the process of evaluating the resilience and stability of financial institutions, portfolios, or systems under adverse economic scenarios. The primary goal is to assess how well entities can withstand and recover from severe financial shocks or stress events.

Stress testing plays a crucial role in risk management, allowing financial institutions and regulators to identify vulnerabilities and potential weaknesses in the financial system.

Stress testing identifies and analyses various scenarios in the banking system such as the impact of defaults by the top 10 customers or fraud by the top 2 percent of customers. Based on such stress testing outcomes, the regulator prescribes remedial actions.

According to Kranthi Bathini, director of equity strategy at WealthMills Securities, the RBI governor probably suggested continued stress testing to NBFCs and banks to be more careful as they are custodians of public money.

The RBI governor had earlier indicated that some segments of loans are growing rapidly.

According to experts, companies are likely to take up stress testing only if it becomes a rule.

Ashvin Parekh, managing director of Ashvin Parekh Advisory Services, said the governor extended his strategy to manufacturing companies, saying that even those companies and their boards should conduct stress testing for the risks they carry.

"If the supply chain were to get disrupted, or let's say all the raw material goes up by a certain percentage, what could be the impact on profitability? What could be the impact on their capital and things like those (need to be put under stress test),” he said.

The RBI’s 2023 Financial Stability report said that macro-stress tests for credit risk revealed that scheduled commercial banks are well-capitalised and all banks would be able to comply with the minimum capital requirements even under adverse stress scenarios.