PRMIA- HYDERABAD CHAPTER
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Financial Stability
B. YERRAM RAJU
REGIONAL DIRECTOR
This presentation is based on the RBI Report on Financial
Stability enclosed to the RBI Bulletin April 2010.
1
When and Why think of Stability?- The
Crisis and Consequential instability?
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• The crisis started in summer 2007 with
lightning failure of Lehman Brothers,
Washington Mutual Funds and 3 Iceland
Banks.
• Mistrust and fear spread among Banks.
• Four Risk environmental factors still being
probed:
– Financial Risk valuation
models/methods
– Risk Control Functions
– Risk limiting strategies and
– Bonus Culture.
A Perspective on the Indian Approach on
the Financial Policy Making
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• Prudential policy framework for banks
addressing:
– Leverage, liquidity, and counterparty
concentration
– Recognition of NBFCs as systemically
important and extension of regulatory
perimeter
– An Active Capital Account management
framework
– Explicit regulation of key OTC
derivative markets.
• Despite relatively low exposure to global
markets, the contagion impact of any global
shocks not ruled out.
3
Healthy Banking sector
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•Tighter regulatory standards on
capital, liquidity and leverage for
banks;
•Unregulated systematically important
financial entities (NBFCs, Coops)
brought under regulatory oversight
•Addressing systemic risks arising from
interconnectedness among financial
sector entities
•Regulating financial markets from a
systemic risk perspective.
4
Key underpinnings
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•Ensuring that
– the process of being away from
disintermediation is genuine
– A clear, transparent capture of
the risks within the prudential
framework exists in the
treatment of NBFCs
•Credit quality robust
•Share of low cost current and savings
account deposits (CASA) is high
•Banks are required to hold a minimum
percentage of their liabilities in risk
free government securities.
5
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•“Maintenance
of
financial
stability
involves trade-offs and raises a number
of
challenges.”
(Financial
Stability
Report, RBI, April 2010)
6
What is Financial Stability
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•It is “a situation in which the financial
sector provides critical services to the
real economy without any discontinuity.”
•Absence of financial instability:
‘containment of the likelihood of failure of
individual financial firms or any systemic
stress and thereby limiting the associated
costs to the economy.’
•Arresting the possible consequence of
‘unknown unknowns’ and realising the
limitations of modeling apparatus and
stress testing exercises.
7
Financial Stability Board
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• Set up by G-20 in the aftermath of recession.
• Mandated to
– Assess vulnerabilities affecting the global financial
system
– Identify and review the regulatory, supervisory
and related actions needed to address them and
their outcomes;
– Promote coordination and information exchange
among the authorities responsible for FS
– Monitor and advise market development and their
implications for regulatory policy;
– Advise and monitor best practices
– Undertake joint strategic reviews of policy
development work on developing international
standards
– Set guidelines for and support establishment of
supervisory colleges
– Support contingency planning for cross-border
crisis management
– Collaborate with the IMF to conduct Early Warning
System
– Undertake any other tasks members may seek to
perform.
8
Central Banks and
FS-Key Aspects
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• Supervision of individual firms from a systemic
perspective
• Greater involvement of central banks where it
is found wanting in supervision of systemically
important entities
• A collegial body of government/central
bank/regulators
• Reorientation of regulatory mandates of all
regulators to also take into account a systemic
perspective.
• Monetary stability supports sound investment
and sustainable growth leading to FS
9
Principal Perspectives of FS
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•FS has critical influence on price stability
and sustained growth
•FS facilitates efficient transmission of
monetary policy actions
•From the regulatory and supervisory
angle, FS safeguards the depositors’
interests and ensures stability of the
financial system.
10
Capital Account
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Buttressed through the imposition of
prudential safeguards in respect of access
of foreign entities to the domestic debt
markets and on forex borrowings by
domestic corporates. (Cap on FII
investments in Corporate (US$15bn) and
Government (US$5bn) bonds.
11
Liquidity Management
Exposure Norms for Commercial Banks
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Exposure to
Limit
1, Single borrower
15% of capital fund
(Additional 5% on
infrastructural component)
40% of capital fund
(Additional 10% on
infrastructure exposure)
10% on capital fund
15% on capital fund
20% on capital fund
2. Group Borrowers
3. NBFC
4. NBFC-AFC
5. Indian Joint venture
/wholly owned
subsidiaries
abroad/overseas step
down subsidiaries of
Indian corporates
12
Liquidity Management (contd)
Exposure Norms for Commercial Banks
Exposure to
6. Capital Market Exposure
(a) Banks holding
shares in any
Co.
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(b)
(c)
(d)
(e)
(f)
Banks’
aggregate
exposure (solo
basis)
Group basis
Banks’ direct
exposure (solo)
Banks’ direct
exposure
(group)
Gross holding of
capital among
banks/FIIs
Source: RBI FSR-2010 p 8
Limit
The lesser of 30% of paid
up share capital of the Co.,
or 30% of the paid up cap of
banks
40% of its net worth
40% of its consolidated net
worth
20% of net worth
20% of net worth
10% of capital fund
13
What made us distinct?
• The counter-cyclical regulations applied ahead of the global crisis
helped us cushion against systemic instability.
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• Significant reduction in risk and rebound in market activity
• Pressures on banking sector liquidity during the crisis together with
extraordinary measures taken led to shortening of the maturity
profile of bank liabilities
• Banks facing large refinancing needs in the following years
• Management of funding risks skillfully
• More stable customer deposits
• Sovereign and corporate CDS spreads broadly stabilised in Q2-2009
• Corrections in equity prices in Emerging Market economies witnessed
largely declines in the range of 30-67 percent.
• Gains started only in the Q3-2009
• Stimulus measures significantly increased global liquidity.
• Forex markets – RBI’s presence in the market helped manage
volatility –Forward Premia in Indian forex markets lower than the
rate dictated by interest differential.
Regulatory Counter-cyclical
Measures
Date
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Capital Mkt
Housing
Other Retail Comm
Real Estate
NBFC-ND-SI
Risk
wt
Provision
Risk
Wt
Provision
Risk
Wt
Provision
Risk
wt
Provision
Risk
Wt
Provision
Dec 04
100
0.25
75
0.25
125
0.25
100
0.25
100
0.25
Jul 05
125
0.25
75
0.25
125
0.25
125
0.25
100
0.25
Nov 05
125
0.40
75
0.40
125
0.40
125
0.40
100
0.40
May-06
125
1.0
75
1.0
125
1.0
150
1.0
100
0.40
Jan-07
125
2.0
75
1.0
125
2.0
150
2.0
125
2.00
May- 07
125
2.0
50-75
1.0
125
2.0
150
2.0
125
2.00
May-08
125
2.0
50100
1.0
125
2.0
150
2.0
125
2.00
Nov- 08
125
0.40
50100
0.40
125
0.40
100
0.40
125
0.40
Nov-09
125
0.40
50100
0.40
125
0.40
100
1.00
100
0.40
15
GDP Outlook
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• Increasing business cycle correlation between
developed and developing economies that
enabled India’s current and capital a/c flows
more than doubled from les than half of the
country’s GDP in 1991 to over 100% of GDP in
the last two years.
• Indian economy continued to be driven largely
by domestic demand notwithstanding
increasing globalization.
• Overall macro economic conditions affected by
adverse shocks in farm sector growth –
deficient monsoon;associated drought and
flood in certain parts of the country; decline in
kharif production of food grains and oil seeds.
GDP Outlook Contd..
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• Tangible recovery since April 2009 in industry and
services
• Upward bias strengthened due to
– Recovery in industry & core
infrastructure
– Upturn in business & consumer
confidence reflected in revival of
consumption and investment demand
– Revival in exports and capital flows
– Recovery in stock market
– Higher resource mobilization thru
public issues and private placements
• RBI’s growth forecast revised to 7.5% in 09-10
Exit Process had begun
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•SLR restored to 25% - on May 26 reduced
to 24.5% to provide more liquidity in the
wake of 3-G cash requirements of
Telecom Companies.
•Export Credit refinance back to 15%
•Non-standard refinance facilities to
commercial banks discontinued
•Jan 2010- CRR hiked by 75 basis points to
5.75%
•Repo and Reverse Repo hiked by 25 basis
points.
18
Key Fiscal Indicators (Centre and States)
(per cent to GDP)
Year
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2003-04
2004-05
2005-06
2006-07
2007-08
2008-09 RE
2009-10 BE
Primary
Deficit
Revenue
Deficit
Gross
Fiscal
Deficit
Outstanding
Liabilities
2.1
1.3
1.0
0.0
-1.1
3.4
4.3
5.8
3.5
2.7
1.3
0.2
4.1
5.1
8.5
7.2
6.5
5.4
4.1
8.5
9.7
81.1
78.6
77.2
74.3
72.0
71.6
73.2
RE: Revised Estimates. BE: Budget Estimates.
NOTE: Negative sign indicates surplus.
Source: Budget Documents.
19
Movements in Monetary Policy Instruments and BPLRs
Phase
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Monetary
Tightening Phase
Monetary Easing
Phase
(Mar 2004 – Sep
2008)
(Sep 2008 – Nov
2009)
CRR
450
(-)400
Repo Rate
300
(-)425
Reverse Repo Rate
150
(-)275
Public Sector
Banks
325-350
(-)125 – (-)275
Private Banks
225 – 375
(-)100 – (-)125
Foreign Banks
100 – (-)150
(+)50 – 0
Bench mark Prime
Lending rates
Source: RBI Report of the Working Group on Benchmark Prime Lending Rate,
October 2009
20
Liquidity ratios
Liquidity Ratios
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Mar05
Mar06
Mar07
Mar08
Mar09
Sep09
Dec09
1
(Volatile Liabilities –
Temporary assets)/
(Earning Assets Temporary Assets) –
(%)
34.7
38.4
41.4
43.9
43.9
45.7
45.1
2
Core Deposits/Total
Assets – (%)
53.8
53.9
52.2
49.3
48.4
51.0
52.0
3
(Loans + Mandatory
CRR + Mandatory
SLR + Fixed
Assets)/Total Assets
– (%)
75.0
79.9
83.4
85.9
79.6
81.4
83.3
4
[Loans +Mandatory
CRR + Mandatory
SLR + Fixed
Assets]/Core Deposits
1.4
1.5
1.6
1.7
1.6
1.6
1.6
5
Temporary
Assets/Total Assets –
(%)
28.8
30.3
43.4
52.0
47.6
39.9
40.0
6
Temporary
Assets/Volatile
Liabilities
0.54
0.53
0.65
0.71
0.69
0.61
0.61
Source: RBI Supervisory Returns
21
Liquidity Ratios
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NO
Ratio
Components
Significance
1
(Volatile
liabilities –
Temporary
Assets)/(Earnin
g Assets –
Temporary
Assets)
Volatile Liabilities:
(Deposits + borrowing bills payable upto 1 year)
Letters of credit – full outstanding ComponentWise CCF of other contingent credit and
commitments Swap funds (buy/sell) upto one
year
Measures the
extent to which
hot money
supports bank’s
basic earning
assets. Since the
numerator
represents shortterm, interest
sensitive funds, a
high and positive
number implies
some risk of
illiquidity.
As per extant norms, 15 per cent of current
deposits (CA) and 10 per cent of savings deposits
(SA) are to be treated as volatile and shown in 114 days time bucket; remainder in 1-3 years
bucket. Hence CASA deposits reported by banks
as payable within one year are included under
volatile liabilities
Borrowings include from RBI, call, other
institutions and refinance
Temporary assets:
Cash
Excess CRR balances with RBI
Balances with banks
Bills purchased/discounted upto 1 year
Investments upto one year
Swap funds (sell/buy) upto one year
Earning Assets:
Total assets – (Fixed assets + Balances in current
accounts with other banks + Other assets excl.
leasing + Intangible assets)
22
No
Ratio
Components
Significance
2
Core deposits/Total
Assets
Core deposits:
All deposits (including CASA) above I
year + net worth
Total Assets: Balance sheet footing
Measures the extent to
which assets are funded
through stable deposit
base.
3
(Loans + mandatory
SLR + mandatory CRR
+ Fixed Assets)/Total
Assets
Gross Advances
Required SLR
Required CRR
Fixed assets
Loans including mandatory
cash reserves and statutory
liquidity investments are
least liquid and hence a
high ratio signifies the
degree of ‘illiquidity’
embedded in the balance
sheet.
4
(Loans + mandatory
SLR + mandatory CRR
+ Fixed Assets)/Core
deposits
Advances
Required SLR
Required CRR
Fixed assets
Measure the extent to
which illiquid assets are
financed out of core
deposits.
Greater than 1 (purchased
liquidity)
Less than 1 (stored
liquidity)
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No
Ratio
Components
Significance
5
Temporary
Assets/Total
Assets
Measures the extent of available
liquid assets. A higher ratio
could impinge on the asset
utilisation of banking system in
terms of opportunity cost of
holding liquidity
6
Temporary
Assets/Volatile
Assets
Measures the cover of liquid
investments relative to volatile
liabilities.
A ratio of less than 1 indicates
the possibility of a liquidity
problem.
7
Volatile
liabilities/Total
Assets
8
(Market value
of Non – SLR
Securities +
Excess SLR
Securities) /
(Book Value of
Non – SLR
Securities +
Excess SLR
Securities)
Item 5 divided
by item 6
Measures the extent to which
volatile liabilities fund the
balance sheet.
Measures the market value of
non – SLR securities and excess
SLR securities relative to their
book value. A ratio exceeding 1
reflects that a bank stands to
gain if it sells off its saleable
portfolio
Source: Report of the Committee on Financial Sector Assessment.
24
Rating Outlook of Banks
(Long term Instrument)
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(hybrid Instruments)
Rating as
on March
31,2009
Rating as
on
November
30,2009
No. of
Banks
assessed
25
26
Positive
01
-
Stable
19
25
Negative
05
1
Rating as
on March
31,2009
Rating as
on
November
30,2009
25
25
-
01
Stable
18
23
Negative
07
1
No. of
Banks
assessed
Positive
Source:CRISIL
25
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Banks assessed
Long Term rating
Positive
Stable
Negative
Rating as on
March 31,2009
Rating as on
November
30’2009
27
0
24
3
28
3
20
5
Note: The numbers pertain to long – term instruments
only (both national and
international), Hybrid ratings
where assigned, carry a lower rating but the same outlook
as the bank’s long – term rating.
Source: Fitch
26
Different Regulatory Norms of UCBs
Tier I bank
Tier II bank
Definition
Deposits less than Rs.100
crore
Other cooperative banks
NPA norm
180 days loan delinquency
norm for loan accounts till
March 2009
90 days loan
delinquency
Asset classification
norm
The 12 month period for
classification of a substandard
asset in doubtful category is
effective from April 1, 2009
The 12 month period for
classification of a
substandard asset in
doubtful category has
been effective from April
1, 2005
Provisioning Norms
Standard Assets:0.25%
Standard Asset: 0.25%
to 0.40%depending on
loan category. Fresh
accretion Doubtful Asset
for more than three
years
March 31,2007 – 50%
March 31,2008 – 60%
March 31,2009 – 75%
March 31,2010 – 100%
Doubtful assets
outstanding for more
than three years 100%
from March 31,2007
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Source: Reserve Bank of India
27
Deposits Advances and Investments of SUCBs
(Growth per cent)
Mar 2008 over
Mar 2007
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Total Assets
Capital &Reserves
Deposits
Borrowings
SLR Investments
Non SLR Investments
Gross loans &
Advances
17.2
29.8
19.7
7.9
17.0
39.5
16.1
Sep 2008 over
Sep 2007
14.9
17.5
16.6
-2.5
12.8
23.9
18.8
Mar 2009 over
Mar 2008
13.2
25.9
13.6
15.2
13.3
19.9
13.7
Source: RBI on Trends and Progress
28
Major Sources of Funds of NBFCs – ND - SI
Source of Fund
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1.
2.
3.
4.
5.
March 2008
(Percentage
to total
liabilities)
March 2009
(Percentage
to total
liabilities)
21.7
4.9
19.8
5.4
14.1
28.3
4.5
18.5
2.8
15.2
Debentures
Commercial Paper
Borrowing from Banks and Fis
Inter – corporate Loans
Others
Source: RBI Report on Trend & Progress of Banks.
29
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S.
No
Approach
The earliest
date of
making
application
by banks to
the RBI
a.
b.
c.
d.
Internal Models Approach (IMA) for
Market Risk
The Standardised Approach (TSA) for
Operational Risk
Advanced Measurement Approach (AMA)
for Operational Risk
Internal Ratings – Based (IRB)
Approaches for Credit Risk
(Foundation – as well as Advanced IRB)
April
April
April
April
1,
1,
1,
1,
2010
2010
2012
2012
Likely date
of approval
by the RBI
March 31,
2011
September
30, 2010
March 31,
2014
March 31,
2014
Source: Reserve Bank of India
30
Macro Economic Environment
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• Global activity contraction of 0.8% in 2009
expected to recover by about 3.9% in 2010
(IMF-World Economic Outlook Jan)
• Global inflation remained subdued slipped into
negative territory
• Anaemic aggregate demand, sharp decline in
oil prices since mid 2008
• Major corrections of agricultural commodity
prices and metals
• Decline in capacity utilization
• Transfer of financial risks to sovereign balance
sheets and higher public debt levels added to
financial stability risks and complicated the
stimulus-exit process
31
Soren Ramdhan Research
Findings
• Financial Crisis started in summer 2007 with the lightning failure
of Lehman Bros and Washington Mutual Funds and 3 Iceland Banks
• It spread mistrust and fear among Banks and FIs
• Four Risk Environmental Factors still being probed:
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–
–
–
–
Financial Risk valuation models/methods
Risk Control Functions
Risk limiting strategies and
Bonus culture
• Empirical evidence shows that financial risk performance was
related with the factors: financial risk valuation models/methods
and risk control functions. The factor risk control functions with the
financial risk performance have a stronger relation than the factor
financial risk valuation models/methods with financial risk
performance.
• Remarkably, no evidence is found to support the relation between
financial risk performance and the factors: risk-limiting strategies
and bonus culture.
• Financial institutions can achieve better financial risk
performance by emphasizing more on the risk environmental
conditions related with financial risk valuation
models/methods and risk control functions.
Introduction (1)
Background/sc
ope
Root of the financial
Scope of the
Financial
crisis
research
Risk
Underestimated
crisis
environmental
financial risk
Started in
conditions
2007
Risk
Perfectly
environmental
estimated
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conditions
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Risk
environmental
factors
Researc
h
objectiv
e
MRQ1
14-3-2016
Financial risk
performance
To identify the relation between financial risk performance
of the last years and risk environmental factors influencing
the performance.
What were the risk environmental factors behind the financial
risk performance?
33
Introduction (1)
Need
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Challeng
e
Perspecti
ve
Opportun
ity
14-3-2016
Reason
Effective financial risk management in the future.
Learning from the past can be a solution for the
future
To identify the significant REC’s.
Risk practitioners, it is their
performance.
To re-engineer the risk matrix and spread risk
culture seamlessly integrating with the
Business of the organization
34
Introduction (2)
The research model and
questions
To what extent was financial risk performance
To what extent was financial risk per
related with financial risk valuation models/methods?
related with risk control functions?
The independent
variables
The risk environmental
Financial
factorsrisk
valuation models
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control
functions
Risk-limiting
strategies
H0
1
H0
2
H0
3
The dependent
variable
Financial risk
performance
(Estimated
financial risk)
H0
Bonus culture
4
To what extent was financial risk perf
related with risk-limiting strategies?
To what extent was financial risk performance
related with bonus culture?
14-3-2016
35
Conclusions
Financial risk performance (FRP) was related
with financial risk valuation models/methods.
The beta of 0.331 is the extent of the relation
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FRP was related with risk control functions
(highest significant predictor).
The beta of 0.381 is the extent of the relation.
FRP was not related with risk-limiting
strategies.
FRP was not related with bonus culture
Overall risk management failed due to: 1)
Underdeveloped financial risk valuation
models/methods, 2) Poor performance of risk
control
functions
The determinants
of FRP are RISK DRIVERS
14-3-2016
related with the following 13 REC’s: Data,
market variables, qualitative valuation methods, tail
loss, stress test, and group-wide risk, system risk,
solvability and integrity, strategic risk decision, dayto-day operational risk activities, and traders’ risk-36
awareness.
Recommendations (1)
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Financial institutions must emphasize more
on the risk drivers related with the (13) REC’s
by ensuring proper governance around the
risk drivers.
Regulators must extend their control
activities among the risk drivers related with
the (13) REC’s to ensure that a proper
governance is applied among FI’s
Management of Risk Evaluation Controls holds the key
14-3-2016
© Soerinder Ramadhin
37
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Thank You
Hyderabad@prmia.org