Shaktikanta Das: Emerging challenges to financial stability
Inaugural address by Mr Shaktikanta Das, Governor of the Reserve Bank of India, at the FIBAC
2019, the Annual Global Banking Conference organised by the Indian Banks' Association (IBA)
and the Federation of Indian Chambers of Commerce and Industry (FICCI), Mumbai, 19 August
2019.
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It is indeed a matter of great pleasure for me to be here today amidst the business and financial
sector leaders. My compliments go to the partners, namely, the Indian Banks' Association, FICCI
and the Boston Consulting Group for spearheading this event. What really gives me the
additional motivation to address you is the earnestness with which you have themed this year's
conference, showing your appreciation of the need to prepare ourselves for a new paradigm in
banking. The happenings of the past, especially the not so remote ones, have generated an
attitude towards the financial sector that ranges from an existential angst to a more positive
outlook that hinges on the opportunities beckoning at us. I would like to believe that solutions to a
better future lie in unlearning from the practices which led to that angst and in relearning to befit
ourselves in the changing financial landscape. Prudent governance and emerging trends in the
digital space have the potential to reshape the way we perceive finance. Against these broad
underpinnings, let me present my thoughts highlighting emerging challenges to financial stability.
This would be the theme of my address to this august gathering.
2. A consensus on the definition of the term financial stability remains elusive even today. Broadly
speaking, the core principles governing financial stability can be thought of in terms of a financial
system's ability to facilitate efficient allocation of economic resources; its effectiveness in
assessing, pricing, and managing financial risks; and in maintaining its capability to perform
these key functions even when affected by external shocks. In other words, as one IMF research
paper of 2004 puts it, a financial system is in a range of stability whenever it is capable of
facilitating the performance of an economy, and of dissipating financial imbalances that arise
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endogenously or as a result of significant adverse and unanticipated events .
The Global Context
3. The global approach to financial stability changed significantly after the financial crisis of 2008
which made it abundantly clear that financial strength of every financial institution does not add
up to systemic stability. The policy makers realised that micro-prudential regulations have to be
complemented with systemic risk measures; otherwise systemic stability could be at risk.
4. Ten years after the crisis, the major financial sector reforms, called for by the G20 and
coordinated by the Bank for International Settlements (BIS) and Financial Stability Board (FSB), are
now mostly in place. Large banks are better capitalised, less leveraged and more liquid. The
banking system is, therefore, more resilient to economic shocks. Implementation of
Too-Big-ToFail (TBTF) reforms is advancing, including via the establishment of effective resolution regimes
for banks. Over-the-counter (OTC) derivatives markets have been made simpler and more
transparent. The use of central clearing has increased, and collateralisation is more widespread.
Those aspects of non-bank financial intermediation that contributed to the financial crisis have
declined. However, the implementation of reforms is not yet complete and remains uneven,
especially in the non-banking space. It goes without saying that while dealing with all these
issues, country specific situations have to be factored in.
5. Recent developments in the global economy should be seen in this perspective. A weaker
than expected growth with signs of slowdown in major economies, as projected by multilateral
institutions like the International Monetary Fund (IMF), is one of the key risks to global financial
stability at this juncture. Looming trade-tensions, geo-political risks, and related uncertainties
continue to exert pressure on the investment outlook. The latest Global Financial Stability Report
(GFSR) by the IMF warns that because of these developments, vulnerabilities in the sovereign,
corporate, and non-bank financial sectors are elevated by historical standards in several
systemically important countries and regions. Under these circumstances, central banks and
other regulators are required to follow the cardinal principle - the regulator never sleeps. Cutting
the hyperbole out, what it means is that the regulators and other authorities need to be constantly
vigilant and proactively take whatever steps that are necessary.
6. The current state of the global banking sector also presents a story of uncertainty. While bank
capitalisation has increased significantly in the post-crisis period primarily due to Basel III
reforms, bank profitability has been lacklustre. Both macroeconomic and bank-specific factors
have contributed to this phenomenon. Importantly, banks are also facing increasing competition
from non-traditional players, such as FinTech and BigTechs, which are taking advantage of
digital innovation. These developments have implications for financial stability in Emerging Market
Economies (EMEs) like India. It is indeed imperative that banks capitalise on these technological
advances and the associated business models. Regulators on their part also need to provide
enabling frameworks for these endeavours by banks as well as the non-traditional players.
The Indian Scenario
7. The pursuit of financial stability has always been a policy priority in India. The twin concerns of
monetary and financial stability constitute the core objectives of the Reserve Bank. Similar to the
global case, India also responded to the crisis by introducing changes in the existing institutional
architecture to further the cause of financial stability. Recognising the various channels that could
lead to systemic instability and the fact that different segments of financial systems are regulated
by different regulators, the institutional mechanisms of the Financial Stability Development
Council (FSDC), under the Chairmanship of the Finance Minister, and the FSDC sub-committee,
under the chairmanship of Governor, Reserve Bank, have been fully functional. The biannual
Financial Stability Report (FSR), a report of FSDC sub-committee, analyses the current state of
financial system, the extent of interconnectedness among its various segments and possible
sources of vulnerabilities that could impact domestic financial stability.
8. The headwinds to financial stability could emanate from various sectors of the economy,
namely, (i) the credit market; (ii) financial markets; (iii) external sector; and (iv) payment system.
It may emanate from some other sources as well. But today, I will focus on these four aspects.
Headwinds from Banking Sector
9. In India, the credit market is dominated by the banking sector which plays a key role in financial
intermediation in the economy. Soundness of the banking system may have a bearing on the
financial stability through various channels - excessive credit growth; maturity mismatches and
liquidity issues; high proportion of non-performing loans; and overleveraging, among others. Even
if individual institutions are robust, the overall behaviour of the financial sector can pose a
systemic risk. Hence, monitoring the health of the banking sector is crucial for financial stability.
10. In recent years, as a result of efforts by both the Reserve Bank and the Government, the
overhang of stressed assets in the banking system has declined. Going forward, the
macrostress tests for credit risk conducted by the Reserve Bank indicate that under the baseline
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scenario, the GNPA ratio may decline further by March 2020 . Other indicators like the provision
coverage ratio (PCR), capital adequacy and return on assets have also improved. I have earlier
stressed that the real test of performance, efficiency, internal stability and governance
improvement in public sector banks (PSBs) would be their ability to access capital markets
rather than looking at the Government as a recapitaliser of first and last resort.
11. Despite certain teething problems, the Insolvency and Bankruptcy Code (IBC) is proving to be
a game changer. New norms for resolution of stressed assets framed in June 2019 by the
Reserve Bank provide incentives for early resolution, with discretion to lenders on resolution
processes. The objective is to ring-fence future build-ups of NPA stress and protect the banking
sector. The recent amendments to the IBC should also be able to facilitate faster resolution of
stressed assets.
12. As we have seen in the recent past, the build-up of risks among regulated entities due to
interconnectedness, exposure concentrations, non-transparent market practices, governance
deficiencies, and their contagion effects have repercussions for financial stability. In this regard,
the Reserve Bank is keeping a close watch on the interconnectedness of banks and non-banks.
The Working Group on Core Investment Companies (CICs) has already started its deliberations
and based on its recommendations, the Reserve Bank proposes to carry out necessary
changes in the regulatory architecture for CICs. We are also in the process of building a
specialised regulatory and supervisory cadre for regulation and supervision of banks and
nonbanks.
13. Another important issue in this context is the immediate need to strengthen corporate
governance structure in banks, which I have elaborated earlier as well. This would include
efficient functioning of their boards and board sub-committees, especially audit and risk
management committees; robust system for monitoring of performance of MDs/CEOs; and, an
effective performance evaluation system to improve the financial and operating parameters of
banks. We have already sent our suggestions to the Government for governance reforms in
PSBs. Overall, it is important that risk management systems, compliance functions, and internal
control mechanisms are strengthened and made more dynamic.
Non-Banking Sector
14. Coming to the NBFC sector, we all know that this sector complements the banking sector
and aspires to act as the bridge to provide last mile connectivity. Further, niche NBFCs fulfil the
unmet and exclusive credit needs of infrastructure, factoring, leasing and other such activities.
Non-traditional and digital players are now entering this space to deliver financial services by way
of innovative methods involving digital platform. There is a web of inter-linkages of the NBFC
sector with the banking sector, capital market and other financial sector entities. The Reserve
Bank keeps a close watch on these inter-linkages to ensure financial stability. With a view to
strengthen the sector, maintain stability and avoid regulatory arbitrage, the Reserve Bank and the
Government have been proactively taking necessary regulatory and supervisory steps. It is our
endeavour to have an optimal level of regulation and supervision so that the NBFC sector is
financially resilient and robust. We will not hesitate to take whatever steps are required to
maintain financial stability in the short, medium and the long-term.
15. Our objective is to harmonise the liquidity norms between banks and NBFCs, taking into
account their unique business models. We are also looking at governance and risk management
structures in NBFCs. Recently in May 2019, NBFCs with a size of more than ₹5,000 crores have
been advised to appoint a functionally independent Chief Risk Officer (CRO) with clearly
specified role and responsibilities. This is expected to bring in professional risk management to
the working of large NBFCs.
16. The move to bring Housing Finance Companies (HFCs) under the regulatory ambit of the
Reserve Bank is significant, given their asset-liability profiles. Including HFCs, the size of the
NBFC sector constitutes about 25 per cent of combined balance sheet of scheduled commercial
banks. The Reserve Bank will take necessary measures to deal with these challenges.
Headwinds from Financial Markets
17. Apart from banks and non-banks, headwinds to financial stability can also originate from
financial markets. The increasing frequency and severity of currency and debt crises globally and
their ability to cause output loss calls for careful regulation and surveillance of financial markets.
Globalization of finance, by amplifying the risk of contagion, and thereby constraining the policy
space for effective regulation, has added to the difficulty of this task. As a regulator of various
market segments such as money markets, G-sec, forex and interest rate derivatives, the
Reserve Bank has followed calibrated, sequenced and careful approach to develop and integrate
these markets. The broad objective has been to keep pace with the requirements of fast-growing
Indian economy, while being vigilant of potential risks to financial stability. This is done through
freeing up market forces by moving away from prescriptive to principle-based regulation, whose
core features are simplification of processes, encouraging product innovation, removing
regulatory differentiation across participant categories and ensuring protection for retail market
participants.
18. Let me give one example. Recently, we have permitted the creation of an electronic platform
on which one can buy or sell foreign currency at market rates. This platform is accessible over
the internet and the customers can get the best market price without having to approach any
individual bank/broker. This is how FinTech can be used to inject greater efficiency to financial
markets.
19. As financial markets are opening up, stability concerns are addressed through capital flow
control measures (e.g., the overall cap on foreign investment in the debt market) or
macroprudential measures (e.g., cap on total external borrowing as a percentage of GDP).
20. Adoption of global best practices to improve market integrity is another important aspect of
regulation. In the last couple of years, the Legal Entity Identifier (LEI) system has been
implemented in a phased manner in all financial markets, including derivative markets regulated
by the Reserve Bank, as well as for bank loans. We believe transparency of financial markets will
greatly improve once the LEI system is used widely. The recent regulations to control market
abuse, upgrade the benchmark setting process are all consistent with global standards.
21. A key feature of regulation of derivative markets has been the differential treatment of
professional and non-expert clients. Moreover, differential access to derivative markets is being
gradually removed. Anyone - resident or non-resident - can now access these markets for
hedging on similar terms. In fact, alignment of incentives for non-residents to gradually move to
the domestic market is an important regulatory aim. As you would be aware, the Task Force on
Offshore Rupee Markets with Mrs. Usha Thorat, former Deputy Governor as chairperson, has
made important recommendations that are likely to improve participation of non-residents in the
onshore market. Our aim is to make the onshore market more accessible and attract higher
transaction volumes.
External Headwinds and Domestic Financial Stability
22. With increased trade and financial linkages with rest of the world, India has become more
susceptible to the vagaries of heightened global economic uncertainties. While trade channels
take some time to show a tangible impact of global shocks, it is the financial and confidence
channels that quickly transmit the global shocks as was evident in the case of India during the
taper tantrum period in mid-2013. In fact with negative and low interest rates in major economies,
net private capital flows to EMEs in the form of direct and portfolio investments have nearly
doubled in the post-crisis period. However, with high monetary policy uncertainties in advanced
economies, these flows have proved to be fluid and therefore posed considerable risk to EMEs.
Just a year back, EMEs like India faced financial market turbulence due to a faster-than-expected
tightening in monetary policies in advanced economies. Many EMEs including India witnessed
portfolio capital outflows, exerting downward pressure on domestic currencies.
23. In recent years, India's external sector has benefited from a sustainable level of current
account deficit, largely financed by robust foreign direct investment inflows and flexible exchange
rate policy. Improvement in other vulnerability indicators during 2018-19 such as fall in external
debt to GDP ratio (from 20.1 per cent at end-March 2018 to 19.7 per cent at end-March 2019)
and debt service ratio (from 7.5 per cent at end-March 2018 to 6.4 per cent at end-March 2019)
also augur well for mitigating the spill over of external headwinds on the domestic financial
markets. Notwithstanding strong macroeconomic parameters, constantly changing dynamics of
external headwinds warrant policy preparedness in order to minimise spill overs of global shocks
and preserve financial stability. As a supplementary safeguard, the Reserve Bank has signed a
bilateral currency swap agreement with the Bank of Japan for US$ 75 billion with the objective of
bringing greater stability in foreign exchange and capital markets in the country.
Payment System and Financial Stability
24. A number of innovations have taken place in retail payments which have reshaped payment
processes and changed the retail payments landscape. India's payment systems are considered
to be efficient, safe and secure. While acknowledging this and without trying to be complacent,
the Reserve Bank has made an attempt to benchmark domestic payment systems and
practices with those prevalent in prominent countries worldwide. The assessment of various
indicators including regulation and oversight suggests that India has a strong and robust
regulatory structure.
25. However, new entrants into the financial services space, including FinTech and BigTech
firms are altering the universe of financial service providers. A range of new lending platforms,
including P2P and marketplace lenders, have appeared in jurisdictions around the world.
Highlighting some of the related challenges and opportunities, the recent Annual Economic
Report of the Bank for International Settlements (BIS) states that such firms can collect large
amount of data at nearly zero costs, which can be used to better assess the riskiness of
borrowers and could reduce the need for collateral to assure repayment. These new players
have also made inroads in the provision of payment services, remittance services and
crossborder payments. Moreover, they have the potential to grow very quickly and become large and
systemically important financial institutions, raising concerns over financial stability and
consumer protection.
26. Faced with such profound changes, the policy makers' dilemma is more than walking the
middle path between innovation and regulation. The public policy approach here needs to be
more comprehensive and holistic, taking into account issues such as financial regulation,
competition policy and data privacy regulation. Coordination among various authorities - such as
financial regulators, competition authorities and data protection supervisors - becomes critical at
this juncture.
27. The Reserve Bank's Vision-2021 for Payment and Settlement Systems in India visualises
empowering every Indian with access to a bouquet of e-payment options that is safe, secure,
convenient, quick and affordable. The Committee on Deepening of Digital Payments under the
chairmanship of Shri Nandan Nilekani has suggested to increase the volume of digital payments
by 10 times in the next three years which can be facilitated by initiatives such as removing
transaction charges on digital payments, simplifying KYC processes, and reducing KYC costs
for banks. The Reserve Bank is taking necessary action based on the committee's
recommendations.
Concluding Observations
28. At the end, I would like to highlight the significance of consumer protection which is not only
important from the point of view of access but also from a broader context of stakeholders' trust.
The trust of the consumers that the services are fairly priced, the trust of the investors that the
stakeholders are acting in their best collective interest, the trust of the regulators that the audited
financial statements do represent a fair and reasonable assessment of the activities of a firm -
all have intangible but substantial contribution to national savings and financial stability. Post
Lehman developments in the US financial markets are a prime and sobering example of what
happens when investor trust evaporates. In fact, consumer protection should be seen as a key
pivot around which all regulatory and supervisory initiatives are required to evolve.
29. Let me conclude by saying that much progress has been made in maintaining a stable
financial system. However, as we have seen, the financial landscape is continuously changing,
and new challenges are emerging. The Reserve Bank is continuously harnessing the regulatory
and supervisory framework to better adapt to the evolving scenario. The IBA, its members and
other stakeholders should, therefore, be active partners in ensuring that such a process evolves
successfully.
1
Garry, J. S. (2004). Defining financial stability. IMF Working Paper, 2004: WP/04/187.
2
Financial Stability Report, June 2019, Reserve Bank of India.