Usha Thorat: Impact of global financial crisis on Reserve Bank of India
(RBI) as a national regulator
Presentation by Ms Usha Thorat, Deputy Governor of the Reserve Bank of India, at the 56th
EXCOM Meeting and FinPower CEO Forum organised by APRACA, Seoul, 29 June 2009.
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I am delighted to be here in Seoul, participating in this 56th EXCOM Meeting and FinPower
CEO Forum - my thanks to Secretary General Bayaua for inviting me to make this
presentation on the "impact of the global financial crisis on RBI as a national regulator".
In order to understand the impact of the global crisis on India and the manner in which the
Reserve Bank of India (RBI) responded, it is important to realise that the RBI is a central
bank that is entrusted with multi-dimensional roles and hence in this talk I propose to analyse
how the RBI responded with respect to several of these roles.
Multi-dimensional roles of the RBI
The RBI is entrusted with several functions, one of the most important one being the
monetary authority of the country. As monetary authority, the RBI has as its objectives price
stability, growth and financial stability. The weight and emphasis accorded to each of these
objectives would vary depending on the overall macro economic conditions. In addition to its
role as monetary authority, the RBI has responsibilities for forex management and
government domestic debt management - both national and sub national. It is also the
banking regulator - it regulates commercial banks, cooperative banks (both rural and urban),
financial institutions and non banking financial companies. It has a developmental role to
ensure inclusive growth - thus, policies on rural credit, SME and financial inclusion are an
integral part of its functions.
Impact of the global crisis on India
The direct effect of the global financial crisis on the Indian banking and financial system was
almost negligible, thanks to the limited exposure to riskier assets and derivatives. The
relatively low presence of foreign banks also minimised the impact on the domestic
economy.
However, the crisis did have knock on effects on the country, broadly, in three ways. First,
the reduction in foreign equity flows - especially FII flows - impacted the capital and forex
markets and the availability of funds from these markets to domestic businesses; second, the
shrinking of credit markets overseas had the impact of tightening access to overseas lines of
credit including trade credit for banks and corporates. Both these factors led to pressure on
credit and liquidity in the domestic markets with the knock on effects, and third, the fall in
global trade and output had impact on consumption and investment demand. The cumulative
impact of all this was a slowing down of output and employment. Despite the slowing down,
India is still the second fastest growing economy in the world.
Moderation in growth
After clocking an average of 9.4 per cent during three successive years from 2005-06 to
2007-08, the growth rate of real GDP slowed down to 6.7 per cent (revised estimates) in
2008-09. Industrial production grew by 2.6 per cent as compared to 7.4 per cent in the
previous year. In the half year ended March 2009, imports fell by 12.2 per cent and exports
fell by 20.0 per cent. The trade deficit widened from $88.5 billion in 2007-08 to $119.1 billion
in 2008-09. Current account deficit increased from $17.0 billion in 2007-08 to $29.8 billion in
2008-09. Net capital inflows at US$ 9.1 billion (0.8 per cent of GDP) were much lower in
2008-09 as compared with US$ 108.0 billion (9.2 per cent of GDP) during the previous year
mainly due to net outflows under portfolio investment, banking capital and short-term trade
credit. As per the estimate made by the RBI in its Annual Policy announced on April 21,
2009, GDP is expected to grow by 6 per cent in 2009-10.
RBI's response as monetary authority
Till August 2008, the RBI followed a tight monetary stance in view of the inflationary
pressures arising from crude, commodity and food prices. In mid-September 2008, severe
disruptions of international money markets, sharp declines in stock markets across the globe
and extreme investor aversion brought pressures on the domestic money and forex markets.
The RBI responded by selling dollars consistent with its policy objective of maintaining
orderly conditions in the foreign exchange market. Simultaneously, it started addressing the
liquidity pressures through a variety of measures. A second repo auction in the day under the
Liquidity Adjustment Facility (LAF) was also re-introduced in September 2008. The repo rate
was cut in stages from 9 per cent in October 2008 to the current rate of 4.75 per cent. The
reverse repo rate was brought down from 6 per cent to 3.25 per cent. The cash reserve ratio
which was 9 per cent in October 2008 has been brought down to 5 per cent. To overcome
the problem of availability of collateral of government securities for availing of LAF, a special
refinance facility was introduced in October 2008 to enable banks to get refinance from the
RBI against a declaration of having extended bona fide commercial loans, under a
preexisting provision of the RBI Act for a maximum period of 90 days. The statutory liquidity ratio
requiring banks to keep 25 per cent of their liabilities in government securities was reduced
to 24 per cent. These actions of the RBI since mid-September 2008 resulted in augmentation
of actual/potential liquidity of nearly $50 billion.
Financial stability objective - RBI's response
The immediate result of tightening of the money and credit markets in October 2008 created
demands on banks that were already expanding credit well beyond the resources raised from
the public by way of deposits. Companies which were substituting overseas credit and capital
market sources with bank funds started withdrawing funds parked with mutual funds and
utilising their undrawn limits with banks. Some of the companies that had issued commercial
paper in the market - especially the real estate companies and the non banking companies -
found it difficult to roll over the maturing paper. The Commercial Paper and Certificates of
Deposit markets became illiquid and mutual funds started facing severe redemption
pressures. Hence, in the interest of maintaining financial stability, the RBI instituted a 14-day
special repo facility for a notified amount of about $ 4 billion to alleviate liquidity stress faced
by mutual funds, and banks were allowed temporary use of Statutory Liquidity Ratio (SLR)
securities for collateral purposes for an additional 0.5 per cent of Net Demand and Time
Liabilities exclusively for this. Subsequently, this facility was extended for Non Banking
Finance Companies (NBFCs) and later to housing finance companies as well. The relaxation
in the maintenance of the SLR was enhanced to the extent of up to 1.5 per cent of their
NDTL.
In order to curtail leveraging, commercial banks, all-India term lending and refinancing
institutions were not allowed to lend against or buy back CDs held by mutual funds. This
restriction was relaxed in the context of the drying up of liquidity for CDs and CPs.
Considering the systemic importance of the NBFC sector, the Government in consultation
with the RBI announced the setting up of a special purpose vehicle (SPV) that could raise
funds from the RBI against government-guaranteed bonds to meet the temporary liquidity
constraints of systemically important non-deposit taking non-banking financial companies
(NBFCs-ND-SI).
RBI's response as forex manager
The RBI assured the markets that it would continue to sell foreign exchange (US dollar)
through agent banks to augment supply in the domestic foreign exchange market or
intervene directly to meet any demand-supply gaps, and did so, especially in October 2008.
It also provided forex swap facility with a three month tenor, to Indian public and private
sector banks having overseas branches or subsidiaries - this acted as a strong comfort to
such banks in the context of the drying up of the overseas money markets. Further, for
funding the swap facility, banks were allowed to borrow under the LAF for the corresponding
tenor at the prevailing repo rate. The forex swap facility of tenor up to three months was
extended up to March 31, 2010. The prudential limit on overseas borrowing by banks has
been doubled.
Taking into account the difficulties faced by exporters, as orders got cancelled and
receivables mounted, the RBI extended the period of concessional pre-shipment and
postshipment export credit. The export credit refinance available to banks from the RBI was also
increased.
Interest rates on dollar and rupee deposits kept in Indian banks by non resident Indians are
capped by the RBI in order to prevent hot money flows. In order to address the impact of
slow down in capital flows, the ceiling rates on these deposits were raised.
The ceiling on the interest rates at which companies could raise funds from abroad were
increased and the end use restrictions that were placed on the deployment of such funds, to
deal with the huge inflows in 2007-08, were restored to the status quo position.
Systemically important NBFCs that were not otherwise permitted to resort to overseas
borrowing were allowed to raise short term foreign borrowings; housing finance companies
were also allowed to access External Commercial Borrowings (ECBs) subject to RBI
approval.
Taking advantage of the discount on Foreign Currency Convertible Bonds (FCCBs) issued
by Indian companies in overseas markets, they were allowed to prematurely buy back their
FCCBs at prevailing discounted rates.
Regulator of banks and NBFCs - RBI's response
As indicated earlier, the Indian banking system was not affected by the global crisis and all
financial parameters have remained strong with capital adequacy ratio for the system at
13.65 per cent (tier I ratio at 8.95 per cent), return on assets over 1 per cent, non-performing
loans around 2 per cent as of March 2009. All commercial banks meet the minimum capital
adequacy norm of 9 per cent and throughout the crisis period, inter-bank markets for money,
forex and debt have been functioning smoothly.
The impact of the crisis in India, as in many Emerging Market Economies (EMEs), spilled
over from the real sector to the financial sector. Industry and businesses especially the Small
and Medium Enterprises (SME) sector had to grapple with a host of problems such as delay
in payments of bills from overseas buyers as also domestic buyers affected by the global
slowdown; increase in stocks of finished goods; fall in value of inventories, especially raw
material, which in many cases were acquired at higher prices such as metal and crude oil
based products; slowing down of capacity expansion due to fall in investment demand;
demand compression for employment intensive industries, such as, gems and jewellery,
construction and allied activities, textiles, auto and auto components and other export
oriented industries. Hotels and airlines apart from IT also saw fall in demand due to global
downturn.
Recognising that the unexpected and swift turn of events could lead to problems of a
spiralling downturn, the RBI took a series of regulatory measures in addition to providing
liquidity and special refinance.
During the years from 2005-6 onwards, in the context of high growth in bank credit to certain
sectors, the RBI had raised in stages the risk weights for these sectors and had also
increased the provisioning requirements for standard assets. In November 2008, as a
countercyclical measure, the additional risk weights and provisions were withdrawn and
restored to previous levels.
The prudential regulations for restructured accounts were modified, as a one-time measure
and for a limited period of time in view of the extraordinary external factors, for preserving the
economic and productive value of assets which were otherwise viable. The modified
regulations were in operation for applications for re-structuring received up to March 31,
2009 and restructured packages implemented within 120 days of receipt of application or by
June 30, 2009, whichever was earlier. Banks were, therefore, required to take swift action for
detecting weaknesses and putting in place the re-structured packages in order to avail of the
benefits in assets classification under the modified prudential regulations. The modifications
permitted the restructured accounts to be treated as standard assets provided they were
standard on the eve of the crisis, viz., September 1, 2008, even if they had turned
nonperforming when restructuring had been taken up. This special regulatory treatment for
restructured accounts was extended to most cases of second restructuring and for first
restructuring of exposures to commercial real estate in view of the sudden downturn. To take
care of the problem of restructured accounts that had become unsecured due to loss in the
value of inventories, special regulatory treatment for asset classification was permitted if
additional provisions were made as prescribed for the unsecured portion.
In the case of NBFCs, having regard to their need to raise capital, they were allowed to issue
perpetual debt instruments qualifying for capital. They were also allowed further time of one
more year to comply with the increased Capital to Risk-Weighted Asset Ratio (CRAR)
stipulation of 15 per cent as against the existing requirement of 12 per cent. Risk weight on
banks' exposures to NBFCs which had been increased earlier was brought down.
The impact of liquidity easing and prudential measures is reflected in the credit growth in the
year ended June 2009 at 15.8 per cent against 26.3 per cent in the previous year. Though
there was slowing down in the period after October 2008, the credit growth in the period
October 2008 to June 2009 clocked annualised rate of 8.9 per cent. The credit growth during
November 2008 - May 2009 was higher than average for sectors such as infrastructure, real
estate, NBFCs, SME, agriculture and certain industries like iron and steel.
Employment intensive sectors - RBI's response
Following the announcement in the Union Budget 2008 in February 2008, the commercial
banks, cooperative banks and regional rural banks implemented in the period till June 2008,
the debt waiver (100 per cent waiver) program for small and marginal farmers and debt relief
(25 per cent relief) program for other farmers, covering an estimated 40 million farmers to the
extent of nearly Rs. 71,000 crore or $14.5 billion. The RBI took sector-specific measures to
alleviate the stress faced by employment intensive sectors such as SME, export and
housing. In order to address the problems faced by the MSEs, meetings of the State Level
Bankers Committee were convened almost on a monthly basis in the first half of this year.
During these meetings, State governments and banks were sensitised about the need to
respond promptly to the credit needs of the sector to ensure that units do not get into
distress. The RBI guidelines on restructuring were disseminated at such meetings.
The RBI extended special refinance of $1.4 billion to Small Industries Development Bank of
India (SIDBI) to enable it to on-lend to banks and financial institutions towards incremental
SME loans. Banks were advised to carve out and monitor separate sub-limits of large
companies to meet payment obligations to micro and small enterprises. MSME (Refinance)
Fund of Rs. 2000 crore ($400 million) was instituted and banks were asked to contribute
towards this fund against their shortfall in their lending to the weaker sections as low interest
deposits with SIDBI to be used by the latter for providing assistance to the MSME sector.
Considering the knock on effects on the housing sector, and the role of housing finance
companies (HFCs) in providing housing loans, the National Housing Bank (NHB) was made
available a refinance limit of $800 million to assist the sector. As in case of SIDBI, banks
were asked to deposit specified amount against the shortfall in their lending to the weaker
sections with NHB. Loans to HFCs were made eligible for the special repo window opened
for bank lending to mutual funds. HFCs were also allowed to borrow abroad from bilateral
and multilateral agencies with prior approval from the RBI.
The period of concessional export credit was extended and the entitlement of banks under
the export refinance facility from the RBI was enhanced. Export-Import Bank of India (EXIM
Bank) was given a special refinance limit of $1 billion as also extended a special forex swap
facility as in case of banks with overseas branches.
RBI's response as debt manager
To contain the knock on effects of the global slowdown, the Government of India announced
three fiscal stimulus packages during December 2008-February 2009. These stimulus
packages were in addition to the already announced post-budget expenditure towards farm
loan waiver, rural employment guarantee and other social security programs , enhanced pay
structure arising from the sixth pay commission, etc. As a result, the net borrowing
requirement for 2008-09 increased by nearly 2.5 times the original projection in 2008-09 from
2.08 per cent of GDP to 5.89 per cent of GDP.
The RBI managed the additional borrowings in a non-disruptive manner through a
combination of measures including unwinding under the market stabilisation scheme (MSS),
open market operations and easing of monetary conditions.
The MSS was introduced in 2004 to help the RBI sterilise the impact of capital flows when
huge accretion to reserves added primary liquidity to the system. Under an agreement
entered into between the Government of India (GOI) and RBI, GOI agreed to issue bills and
bonds the proceeds of which were immobilised with the RBI and thereby the liquidity impact
of forex purchase by the RBI was neutralised. The MSS operates symmetrically, and acts as
a store of liquidity and hence has the flexibility to smoothen liquidity in the banking system
both during episodes of capital inflows and outflows. When capital outflows were
experienced in 2008, and the borrowing requirement of government increased, it was
decided to buy back MSS securities while simultaneously issuing new securities under the
borrowing program. The agreement between RBI and GOI alluded to earlier was amended in
February 2009 to allow the funds immobilised under the MSS to be de-sequestered instead
of going in for fresh borrowing. So far between March and May this year, cash balances of
nearly $8 billion have been de-sequestered.
Keeping in view the government market borrowing in 2009-10 as provided in the interim
budget, coming on top of a substantial expansion in market borrowing in 2008-09, it was
important for the RBI to provide comfort to the market so that the borrowing programme is
conducted in a non-disruptive manner. Accordingly, the RBI simultaneously indicated its
intention to purchase government securities under open market operations (OMO) for an
indicative amount of Rs.80,000 crore ($16 billion) during the first half of 2009-10.
The distribution method for the primary issuances was also shifted to uniform price auction in
view of the uncertain market conditions. Offers of shorter term bonds and benchmark
securities have also helped meet investor preference and stabilise yields.
The general easing of monetary conditions, in addition to the above measures have also
ensured that the additional borrowing needs of the government do not result in crowding out
of credit to the private sector and helped in maintaining stable conditions in the government
securities markets.
Factors that helped in responding swiftly and effectively
In concluding my presentation on the impact of the global crisis on the RBI, I would like to
briefly touch upon the factors that enabled the RBI to respond swiftly and effectively to the
unfolding crisis.
The single most important concern that needed to be addressed in the global crisis was the
liquidity issue. The RBI had in its arsenal a variety of instruments to manage liquidity, viz.,
CRR, SLR, LAF, Refinance, OMO and MSS. Through a judicious combination of all these
instruments, the RBI was able to ensure more than adequate liquidity in the system. At the
same time it was ensured that the growth in primary liquidity was not excessive.
The inherent synergies in its multiple roles enabled the RBI to ensure orderly functioning of
money, forex and government securities markets while dealing with capital flows, managing
additional government market borrowing and ensuring adequate credit to restore growth
momentum.
As regulator and forex manager, the RBI was able to build reserves, calibrate capital controls
and take prudential countercyclical measures which could be reversed when the need arose.
Both, macro prudential and micro prudential policies adopted by the RBI have ensured
financial stability and resilience of the banking system The timely prudential measures
instituted during the high growth period especially in regard to securitisation, additional risk
weights and provisioning for specific sectors, measures to curb dependence on borrowed
funds, and leveraging by systemically important NBFCs have stood us in good stead. The
reserve requirements - both cash and liquidity - acted as natural buffers preventing
excessive leverage.
While credit expansion by private sector and foreign banks was significantly lower during
2008-09 especially to retail and SME borrowers, public sector banks (covering nearly 70 per
cent of banking assets) maintained their credit growth to employment impacting sectors such
as SME, agriculture, real estate and infrastructure, even as regulatory policies have ensured
that prudential norms and financial soundness were not compromised.
Finally, the close coordination and interaction between the Government and the RBI ensured
that appropriate package of measures were put in place promptly to deal with the crisis and
restore the growth momentum. Thank you.