New stress-test formula gets RBI board nod

The central board of the Reserve Bank of India (RBI) wants banking system stress tests to include several parameters in addition to non-performing assets (NPAs), a person aware of the matter said.

The board has discussed doing away with the singular focus on NPAs in the bi-annual stress tests for RBI’s Financial Stability Report (FSR), the person cited above said on condition of anonymity, adding multiple indicators are needed to identify emerging stress in the system.

In its latest FSR released on 11 January, RBI said gross NPAs could rise to 13.5% under the baseline stress scenario by September 30, 2021, the highest in more than 22 years, up from 7.5% as of September 30, 2020. It is predicted to almost double to 14.8% under a severe stress scenario.

“The issue has been discussed at the meetings of the central board and board of financial supervision. Irrespective of the stress tests, which are being done for so many years, RBI couldn’t avert a crisis. It has been, therefore, discussed that RBI should not go by headline figures and should instead have multiple indicators to warn them about impending stress in the system. Indicators like credit disbursement, adoption of information technology across banks, etc., can be looked at for a comprehensive stress test,” the person cited earlier said.

The scrutiny on stress tests comes after market participants raised concerns on the quality of these tests, which differ from projections by banks and rating agencies.

According to the person cited earlier, stress tests should ideally prepare the system to handle a crisis by issuing early warnings.

Kotak Institutional Equities said in a 12 January note to clients that the Reserve Bank forecast places too much emphasis on history, and there has already been a significant default from the large corporate segment in the previous corporate bad loan cycle.

The report said RBI did not provide any details of the stress in the retail and small and medium enterprises (SMEs), which have been most affected by covid-19.