Dear RBI, fix the risk aversion problem to make banks safe from Covid-19
2 min read.Updated: 26 Mar 2020, 10:40 PM ISTAparna Iyer
RBI needs to ring fence the financial system from the Covid-19 impact with a series of measures
The lockdown may be successful in flattening the infection curve, but RBI needs to act quickly to prevent the financial market’s curve from going awry
India’s deteriorating financial system is moving towards a crisis, unless the Reserve Bank of India (RBI) begins to ring fence it against the Covid-19 impact. That would mean giving forbearance to banks, as argued by this column on Wednesday. But forbearance is just one part of the solution.
D. Subbarao, who was at RBI’s helm during the global financial crisis in 2008, said the most important task is to ensure credit to sectors. He recommended targeted measures using macro-prudential policy. “The RBI’s challenge is not rates or liquidity. It is risk aversion," he added. “If you believe that some sectors need support badly than others, then macro-prudential measures are warranted. Loan guarantees by government can be given."
During the financial crisis, RBI had put in place a special purpose vehicle under IDBI Bank Ltd, through which non-banking financial companies (NBFCs) could borrow at cheap rates. The former RBI governor said enhanced credit lines through nodal agencies, such as Nabard and Sidbi, could be made available.
Indeed, several analysts have been highlighting the need for targeted measures. Ananth Narayan, associate professor at SP Jain Institute of Management and Research, favours not just rate cuts and liquidity, but also forbearance, and even a bad bank to deal with legacy bad loans.
“As a more emergency response, the RBI might widen the scope of bond purchases to include corporate bonds if distress proves to be prolonged," wrote Radhika Rao, senior vice president and economist at DBS Bank Ltd, in a note.
But is the risk aversion so bad, and has transmission collapsed?
Before the Covid-19 outbreak, weighted average lending rate on fresh loans of all banks had dropped by a mere 50 basis points, against the 135 basis points cumulative cuts in policy rate over the last one year. The collapse of Infrastructure Leasing and Financial Services Ltd made borrowings expensive even for AAA-rated NBFCs. When the best-rated company finds its borrowing cost rise sharply, small businessmen would find it nearly impossible to borrow.
The virus outbreak has resulted in a complete breakdown of the money market interest rate curve. While the interbank call money rate, and even the tri-party repo rate, have collapsed, commercial paper rates have surged.
This is despite banking system liquidity being in excess of ₹2 trillion. Government bond yields, too, have inched up, notwithstanding purchases through open market operations by the central bank. These are signs that pumping liquidity is having only a limited impact. The impact of policy rate cuts in such a scenario becomes doubtful.
“They will need to cut rates further on, when the lockdown is lifted and the economy is in recovery mode. At that time, rate cuts would be optimal," said Subbarao.
The lockdown may be successful in flattening the infection curve, but RBI needs to act quickly to prevent the financial market’s curve from going awry.