RBI Governor Shaktikanta Das on Saturday indicated that the central bank can consider the idea of a bad bank to tackle non-performing assets (NPAs) and advised banks and non-banks to adopt appropriate compliance culture and identify risks early.
“If there’s a proposal to set up a bad bank, the RBI will look at it. We have regulatory guidelines for asset reconstruction companies,” Das said while delivering the Nani Palkhivala Memorial Lecture.
NPAs of the banking sector are expected to shoot up to 13.5 per cent of advances by September 2021 from 7.5 per cent in September 2020 under the baseline scenario, the Financial Stability Report of the Reserve Bank of India (RBI) said earlier this week. “We are open to look at any proposal to set up a bad bank,” he said.
A bad bank buys the bad loans and other illiquid holdings of other banks and financial institutions, which clears their balance sheet. Banks, led by the Indian Banks’ Association (IBA), had last May had submitted a proposal to set up a bad bank to the Finance Ministry and the RBI, proposing equity contribution from the government and the banks.
According to Das, banks and non-bank financial companies (NBFCs) need to identify risks early, monitor them closely and manage them effectively.
The risk management function in banks and NBFCs should evolve with changing times as technology becomes all pervasive and should be in sync with best international practices, he added.
“In this context, instilling an appropriate risk culture in the organisation is important. This needs to be driven by the board and senior management with effective accountability at all levels,” Das said. Recent events in our rapidly evolving financial landscape have led to increasing scrutiny of the role of promoters, major shareholders and senior management vis-à-vis the role of the board, the RBI Governor added.
With the Union Budget just two weeks away, Das advised the government to define the fiscal roadmap in terms of the quality of the expenditure.
“Going forward, it becomes imperative that fiscal roadmaps are defined not only in terms of quantitative parameters like fiscal balance to GDP ratio or debt to GDP ratio, but also in terms of measurable parameters relating to quality of expenditure, both for Centre and states,” Das said.
Redefining fiscal roadmap
With reference to the Budget, Das said the government should define the fiscal roadmap not only in terms of quantitative parameters, but those relating to quality of expenditure too. This, he said, would ensure continued welfarism as well as sustainable growth.
“While the conventional parameters of fiscal discipline will ensure medium and long-term sustainability of public finances, measurable parameters of quality of expenditure would ensure that welfarism carries significant productive outcomes and multiplier effects,” Das said.
Maintaining and improving the quality of expenditure would help address the objectives of fiscal sustainability while supporting growth, he added.
The RBI Governor noted that the current Covid-19 pandemic related shock will place greater pressure on the balance sheets of banks in terms of NPAs, leading to erosion of capital.
“Building buffers and raising capital by banks — both in the public and private sector — will be crucial not only to ensure credit flow but also to build resilience in the financial system,” Das said.
“We have advised all banks, large non-deposit taking NBFCs and all deposit-taking NBFCs to assess the impact of Covid on their balance sheet, asset quality, liquidity, profitability and capital adequacy, and work out possible mitigation measures including capital planning, capital raising, and contingency liquidity planning, among others,” Das said.
In addition to a strong risk culture, banks and non-banks should also have appropriate compliance culture. Cost of compliance to rules and regulations should be perceived as an investment as any inadequacy in this regard will prove to be detrimental, he said.
Das said a robust assurance mechanism by way of internal audit function is another important component of sound corporate governance and risk management. “It provides independent evaluation and assurance to the board that the operations of the entity are being performed in accordance with the set policies and procedures,” he stated.
The internal audit function should assess and contribute to improvement of the organisation’s governance, risk management and control processes using a systematic, disciplined, and risk-based approach, Das said.