The aim of the Financial Stability Reports would be to provide an assessment of the risks to and the durability of the monetary system at a systemic level. At a previous article , we reviewed the June 2018 Financial Stability Report (FSR) and made a list of themes and priorities along which the RBI can contemplate incremental modifications, like on reforming stress evaluation layout, representing de-anonymised stress evaluation outcomes, and providing an investigation and a story around its chapter on macro-financial risks. In light of this newly published June FSR report, we analyze the demand for the FSRs to have an overall sense of continuity and narrative construction, both inside the present variant and across earlier versions.
The macro stress test results of credit risk (Chart 2.7) for PSBs reveal that the GNPA below the baseline, moderate and severe shock are better compared to Actual. But for PVBs and FBs, the GNPA amounts for the moderate and acute stress scenarios are greater than Actual. It appears anomalous that PSBs, who’ve been doing badly, have their own GNPA ratios reduced under stress scenarios while for different banks, the GNPAs increase.
This is a point that required further investigation and comment by the RBI. While earlier graphs make it crystal clear that PSBs have NPA ratios considerably higher than PVBs or FBs, we find the PCR of FBs is higher than PSBs and PVBs. The RBI provides more in-depth investigation to know what drives this difference, for example, by estimating what percentage of those provisions were due to regulatory requirements and how much was due to proactive provisioning.
The macro stress test contributes to credit risk show that there is an improvement in system-level conditions compared to the results from the December 2018 FSR, together with all the GNPA ratios of their SCBs expected to come down and the system level CRAR values expected to move up (Charts 2.7, 2.8). On the other hand, the lender level sensitivity analysis of credit risk proves that under a serious shock, the system-level effects are greater this time as compared to six months back (December 2018 FSR). Additionally, the reverse pressure test results imply that it required a shock of only 2.9 SD to bring down the system-level CRAR to 9 percent while at the previous FSR, this value was 4.15 SD (Section 2.22, June 2019 FSR). This looks counterintuitive and RBI might have left a comment too.
The Chapter on’Financial Sector: Regulation and Developments’ has in the previous two FSRs prominently dealt with the topic of danger, in just two Boxes, namely’Box 3.4: Risk Staff’ (Dec 2018 FSR), and’Box 3.1: Risk Society — The paradigm of danger?’ (June 2019 FSR). The former deals with how to assess the civilization of risk-taking in monetary institutions while the latter discusses danger for a build within a globalised society. All these, however, do not link back to whether RBI is considering moving towards a more complex capture of operational risks and misconduct dangers that are an essential component of the risk culture of firms, and which have consequences for the broader market. The available analysis in the FSR is limited to ex-post
dissection of banks frauds across bank groups and the quantum of such frauds. A more comprehensive analysis of working risks including supervisory observations on risk culture and also a complaints evaluation, in the Ombudsman, across bank-group types and penalties levied is direly needed.
For any such evaluation to be meaningful and applicable, it’s essential that every FSR provides a commentary on the essential risks and trends identified in the prior FSR and how these have evolved, or maybe not, in the intervening period. Supplying this goodwill could provide context to the strain tests and their outcomes. While the latest FSR does compare the outcomes of the stress tests with the prior FSR, this is achieved in an ad-hoc fashion and without comment.
Some specific instances where demonstrating goodwill could have helped are — Another theme that’s missing, as we mentioned earlier, is narrative construction. The FSR contains a plethora of information in the kind of tables and charts. On the other hand, the narrative after the tables and graphs describes the information presented in the characters without giving a sense of how the RBI perceives those insights. Even though it might be impossible to find out the origin of all trends discovered precisely, a comment on the same by the RBI would provide an insight into the thinking of the central bank and how it views various developments. Some examples to illustrate the purpose are Discontinuity in the thematic exploration — the Dec 2018 FSR had a thematic exploration of the execution of Prompt Corrective Action (PCA) and non-PCA banks whereas the present FSR investigates the developments in the consumer credit and NBFC space.
While both topics were topical, they look disjointed when viewed together. It’s the prerogative of RBI to determine which issues are relevant and research them accordingly. On the other hand, the RBI could make sure that there’s a connecting thread among the subjects it selects and these analyses are complete. For example, while there has been progress with some banks coming from this PCA framework, a significant number of PSBs (Public Sector Banks) are still under PCA. Therefore, it appears that a follow upon the PCA analysis would still be relevant. Nonetheless, these linkages were not formed overnight, and RBI was conscious of those linkages before the liquidity stress hit the NBFC and HFC sectors.
The RBI can therefore instead be proactive in identifying the kinds of institutions which are contributing to the development of dangers in the financial system and include them in the contagion investigation and other pressure tests in a continuous basis rather than as a response to current market events, such as that concerning the housing finance sector that prompted this analysis (See pages 42-45, June 2019 FSR). Change in methodology for anxiety tests — At the bank amount sensitivity evaluation of credit risk, the consequences given into the GNPA ratios, Shock 1 and Shock 2, are 1 SD and 2 SD respectively (Chart 2.10, FSR June 2019).
This is different from the shocks used in variants prior to the December 2018 FSR. By way of example, at the June 2017 FSR (Chart 2.10), five shocks of i)1 SD on NPAs, ii) two SD on NPAs, iii) 3 SD on NPAs, iv) 30 percent of restructured improvements turn to NPAs (sub-standard class, and v) 30% of restructured improvements turn to NPAs (reduction category — composed ) are applied. The rationale for such changes in methodology, when they occur, must be provided because it impacts the interpretation of outcomes and aids better comparative monitoring by the consumers of the FSR reports. The versions differ at the lender level, i.e., across PSBs, PVBs (Private Sector Banks) and FBs (Foreign Banks).
The rationale behind the specific inclusion or exclusion of variables in the design must be offered. By way of instance, the current account balance to GDP ratio and the gross fiscal deficit to GDP ratio are included in the PSB model but not for PVBs and FBs. The exports to GDP factor has been lagged by 1 year and 5 years respectively for PVBs and FBs and has been completely sold for PSBs. Further, these models have been changing over the years with no sufficient explanation for either the choice of the variables or their change.