A bazooka of liquidity & ventilator for credit: RBI's response to covid-19

The prevailing covid crisis and its consequential lockdown across most of the globe has led to an unprecedented, unquantifiable uncertainty. With economic activity immobilized, financial stress is inevitable. Most economists and experts have already stated that comparisons with the global financial crisis or even the world wars are futile, the depth as well as the breadth of this crisis is significantly more sweeping. Adam Tooze, the Columbia University scholar of economic crises aptly said that where the 2008 crisis was a financial heart attack, the prevailing crisis is a full-body seizure.

In this backdrop, the timely and decisive action by the Reserve Bank of India (RBI) provides vital liquidity and ensures that credit lines remain open, so that the economy is not deprived of oxygen, even as the citizens seek to protect their lungs from the coronavirus.

The RBI announced a reduction of the repo rate by 75 basis points, which should bring down the cost of credit significantly. In addition, multiple open market operations and targeted long-term repo operations will inject critical liquidity into the economic system. The RBI’s actions are in alignment with the International Monetary Fund’s (IMF) policy recommendations to central banks for dealing with the economic crisis. In a paper on “Policy Steps to address the Corona Crisis” released by the IMF on March 16, 2020, they recommended that central banks should provide liquidity to support market functioning and ease stresses in key funding markets, through open market operations, and other measures such as outright purchases and repo facilities. The IMF also specifically recommended that monetary easing will support demand and confidence while reducing borrowing costs for households and firms. The IMF also recommended that rate cuts could also be supplemented by forward guidance about the expected path of monetary policy, which could also be a form of stimulus. In this context, the Governor’s statement that the MPC is maintaining the accommodative stance of monetary policy as long as necessary to revive growth, mitigate the impact of covid-19, while ensuring that inflation remains within the target is truly welcome; as is the statement that the RBI continues to monitor the evolving financial market and macro-economic conditions; and that they will re-calibrate operations to meet any need for additional liquidity support as well as other measures, as may be warranted.

In order to maintain access to credit and prevent large-scale economic stress, since the economic impact will severely impede the ability of borrowers to service their loans, of  the RBI has given permitted banks and financial institutions regulated by it- banks (public and private sector, regional rural banks, small finance banks, local area banks and co-operative banks) as well as  all-India Financial Institutions and NBFCs (including microfinance institutions) to allow a moratorium/ temporary suspension of the installments for a 3-month period and also a corresponding extension in the tenor of the term loan. In respect of working capital facilities, the RBI has permitted a moratorium on interest payments for a three month period. There is, however no restriction on borrowers from continuing to repay as per the existing repayment schedule.

The above measure is an appropriate amalgam of proportional and proactive, transparent and time-bound measures to tide over cashflow and credit crises borrowers may be facing. The RBI has given its regulated institutions the enabling power to  provide such a moratorium, subject to putting in place a Board- approved policy. The RBI has also specified that this enabling power is being provided specifically to enable the borrowers to tide over the economic fallout from covid-19 and accordingly such payment moratorium will not be treated as change in terms and conditions of loan agreements due to financial difficulty and will not result in asset classification downgrade. This is crucial since this will allow lenders to extend emergency credit lines allowing businesses to tide over liquidity issues and to support MSME and retail borrowers. Several lenders had already opened such credit lines over the last few days and the RBI’s measures will allow the effective transmission of such facilities. 

Although several other jurisdictions have provided for payment moratorium, the RBI’s actions are measured and calibrated. It is also apposite that they are temporary rather than open-ended and as transparent as possible. It is also critical to maintain the solvency and stability of banks and financial institutions (more so given the pre-covid challenges in the financial system) and avoid an unmitigated increase in non-performing loans in the system, and therefore, the moratorium being both limited to three months as well as linked to covid related constraints to payments will minimise the pressure on financial institutions. The RBI circular released in this context specifies accounts provided relief under these instructions shall be subject to subsequent supervisory review with regard to their justifiability on account of the economic fallout from covid-19.It also requires lending institutions to maintain objective management information systems. Both these requirements will engender cautiousness and accountability in the exercise these enabling provisions, with the tone being set from the top- the board approved policy. 

The RBI has been courageous as well as calibrated in these policy actions and will pave the path to recovery from the present uncertainty.

The authors of this article are Cyril Shroff, Managing Partner; & Richa Roy, Parter, Cyril Amarchand Mangaldas