The RBI Governor address on May 5, 2021 at 10:00 Hours was an unscheduled communication with a lot of announcements around regulatory forbearance. The announcements, even though unscheduled were expected, as the RBI governor has been meeting the heads of various Scheduled Commercial Banks (both public and private), Small Finance Banks and Non-Banking Finance Companies (“NBFCs”) to assess the situations around capital, liquidity and requesting them to continue to keep the taps of credit running. Following were the key announcements made:
- Term liquidity facility for INR 50,000 crores to ease access to emergency health services.
- Special Long Term Repo Operations (SLTRO) for Small Finance Banks.
- Lending by Small Finance Banks to MFIs to be categorized as priority sector lending.
- Reduction in Cash Reserve Ratio for lending to MSMEs.
- Resolution framework 2.0 for Covid related stressed assets of individuals, Small businesses and SMEs.
- Rationalization of compliance to KYC requirements
- Utilization of floating provisions and countercyclical provisioning buffer held till December 31, 2020 allowed for being utilized against specific NPA provisions till March 31, 2022.
- Relaxations towards Ways and Means Advances for state governments.
While the above announcements were made explicitly, what was more useful was the forward guidance that was inherent in the speech. While some of this may be crystal ball gazing, it is an attempt made to decode the thought process of the regulator:
- Congenial Financial Conditions – This would mean that the government would continue to keep the economy surplus with liquidity for the foreseeable future and the RBI could have more unscheduled liquidity windows.
- Markets continue to work efficiently – Efficient markets in times of crisis are usually markets that are managed to keep the economy from going in the negative direction and hence yield curve management will continue and a flattening yield curve will continue to be the norm.
- Commitment to adopt unconventional means – The Government Securities Acquisition Program (G-SAP), will be a tool that will be utilized significantly by the RBI and it should not be a surprise if the same exceeds the 1 trillion Rupee commitments already made by the RBI. Unconventional is also a euphemism used for “strange”, “unhealthy”, “innovative” by many central banks globally.
- Utilization of counter-cyclical buffers till March 31, 2022 – The RBI expects the NPA provisions to hit Banks because of the pandemic till Q3 of FY 2021-22 and has provided till end of FY 2021-22 to utilize 100% of floating provisions till the end of December 2020. We could expect the countercyclical buffers to be back in place from Quarter 1 of FY 2022-23, which could also mean interest rates could be revised upwards with the second MPC of FY 2022-23, given that strong economic growth is one of the triggers for a countercyclical buffer.
- Post pandemic restructuring – Post pandemic restructuring in the form of asset sales to bad banks, will be a significant expectation. There is a separate committee on Asset Reconstruction Companies that has been created for the purpose of addressing the legacy asset quality issue inherent in the system. The same framework would be leveraged to isolate the pandemic induced stressed assets through hair-cuts, the loss for which may be spread across multiple quarters.
- Exchange rate to be maintained within a specific band – With the RBI proposing to keep an accommodative stance, it would be important for the RBI to keep the exchange rate within a specified band to keep the country away from the challenge of importing inflation and keep exports competitive. Currency management would be a key focus area for the foreseeable future.
The regulator is on the right path towards doing things that balance the lives versus livelihood conundrum. However, the unwinding of this path post the pandemic is something that the regulator would need to carefully calibrate. Closing the taps of surplus liquidity in financial system is never an easy process and would require a lot more discipline than one envisages. We expect difficult choices facing the RBI in a post pandemic world, especially as the regulatory forbearance is rolled back.