Covid-19 impact: RBI asks banks to carry out detailed stress testing

Capital-raising, precautionary provisioning may be on cards

The Reserve Bank of India (RBI) has asked banks to carry out detailed stress tests due to the impact of Covid-19 on their books and put capital-raising plans with board approvals in place, if needed. 

This is the first major regulatory move by the central bank to ascertain the health of banks and take proactive measures to ring-fence them after the outbreak of the pandemic. The central bank in its communiqué to chief executive officers of banks on June 19 said stress tests would take into account three scenarios — baseline, medium, and severe stress — which will cover all key financial parameters pertaining to the quality of the book. 

If there is significant capital impairment, clear-cut-board approved capital-raising plans are to be in place.

While “precautionary provisioning for Covid-19 has not been explicitly stated in the letter, it cannot be ruled out”, said a source. This may call for even more capital to be raised by banks, and the sums set aside for state-run banks for their recapitalisation in the Union Budget may need an immediate revisit. The central bank has not set a deadline for banks to conclude the stress-test exercise, but senior bankers opine that some were already looking at this, and will now fast-track it by September-end, when they will have a better picture of their books after the moratorium on the servicing of loans and a 180-day view on the performance of borrowers’ accounts.

The latest RBI move should be read in the light of its pre-Covid Financial Stability Report (FSR-December 2019), which had observed that while the banking sector had shown signs of stabilisation, the performance of state-run banks needed to improve and efforts needed to be taken to build buffers against disproportionate operational risk losses. After Covid-19, this is a given. 

The stress tests had indicated that under the baseline scenario, the gross non-performing asset (GNPAs) ratios of all banks may move to 9.9 per cent by September 2020, from 9.3 per cent in September 2019 due to changes in the macroeconomic scenario, marginal increase in slippages, and the denominator effect of declining credit growth. 

Under severe stress, the GNPA will rise to 10.5 per cent, and for 52 banks, it would move up to 15.6 per cent, from 9.4 per cent. This may require additional tier-1 capital. 

Accordingly, the capital adequacy ratio (CAR) of 53 select banks was projected to come down to 14.1 per cent by September 2020 under baseline expectations and 12.7 per cent under severe stress from 14.9 per cent in September 2019. 

The RBI also noted that three banks had CAR below the minimum regulatory level of 9 per cent by September 2020, without considering any further planned recapitalisation. However, if macroeconomic conditions deteriorate, five banks may record CAR below 9 per cent.

While the central bank had qualified that these scenarios should not be interpreted as forecasts or expected outcomes, it is clear with its latest missive asking banks to undertake post-Covid stress tests that it feels there could be sharp deterioration in key financial parameters, calling for the need to enhance capital buffers significantly.