The recent Financial Stability Report should have analysed central bank’s own contribution to rising banking risk..

Blogging is back after a short break. One remonetised energies but time to get back to demonetising it..

One does not know in recent history a central bank/banking regulator which has enforced the kind of stress on its own banking system. The kind of stress Indian central bank has imposed on Indian banks (and its staff is appalling) and shocking. A former RBI Governor once said the purpose of Indian central bank is to safeguard the Indian public from the Government! But what happens when a central bank attacks all possible safeguards itself? Who saves from the so called saviour?

What is even worse is to see the central bank just excuses itself from the ongoing mess so easily. In the recent Financial Stability Report (Nov 2016), RBI raises concerns on the banking system:

The business of scheduled commercial banks (SCBs) remained subdued mainly due to the muted performance of public sector banks (PSBs). The asset quality of banks deteriorated further between March and September 2016. PSBs continued to record the lowest capital to risk-weighted assets ratio (CRAR) among the bank groups with negative returns on their assets. The banking stability indicator shows that the risks to the banking sector remained elevated due to continuous deterioration in asset quality, low profitability and liquidity. Given the higher levels of impairment, SCBs may remain risk averse in the near future as they clean up their balance sheets and their capital position may remain insufficient to support higher credit growth. Stress tests of SCBs show that their GNPA ratio may increase further if macroeconomic conditions deteriorate sharply. The asset quality of scheduled urban co-operative banks (SUCBs) as well as non-banking financial companies (NBFCs) deteriorated. The capital adequacy of SUCBs, however, improved marginally.

Well this is likely to become worse given how badly banks have been made to follow the diktat of the central bank in last 2  months.

Leave criticising its role or of the polcy in general, the report actually says policy uncertainty has reduced! In the chapter on macro-financial risks it says:

 

While the spillover of global events on the domestic economy may continue to be significant, reduced policy uncertainty, along with tax and legislative reforms will help in realising the benefits from the strong macroeconomic fundamentals. The transition to the nationwide goods and services tax (GST) is guided by the goal of minimal impact on consumer price inflation, even as any reversal in global commodity prices will have to be carefully embedded in the overall considerations of macroeconomic policy.

It treats currency withdrawal as just one such initiative!

Other initiatives such as the withdrawal of legal tender status of specified bank notes (SBNs) could potentially transform the domestic economy. 

How will it transform? This is just hidden in the usual language of economese:

It is expected to significantly transform the domestic economy in due course in terms of greater intermediation, efficiency gains, accountability and transparency through increasing adoption of digital modes of payments, notwithstanding the short-term disruptions in certain segments of the economy and public hardship. 

I mean it is not even funny anymore. It is shocking to see the central bank being so ignorant of the reality and how it has imposed risks on the banking system itself. Suddenly it changed the narrative from sorting the loan/asset book to sorting the black notes from white ones.

Given the first analytical report after the withdrawal, one expected some more analysis and thoughts from the central bank on the exercise. But there is nothing of the sort. It just follows the usual exercise in a highly bureaucratic fashion talking about scenarios like sudden depositor rush (page 31) of 5%, 7%, 10% and 12%. There is no analysis of the central bank order to cancel currency liabilities to the tune of 86% and what risks it has in terms of rising bank deposits and so on.

Frankly one doesn’t understand the purpose of such financial stability reports at the first place. They have failed most of the time to identify whatever risks and read so similar across time periods across countries.

This was also an opportunity for the central bank to thank the Indian banking staff which has selflessly worked on its diktat. This would have given the report a more humane outlook than the usual financial one which anyways is wrong most of the time.

There can be no financial stability if the central bank itself chooses to shock the banking system in such random manner. And based on past historical reading, the banking troubles have just begun. There have been reported episodes across the country of bank staff engaging in all kinds of behaviour which undid the demon exercise. But then there are several others which tried their best to help customers and do their bit. And most likely it is the latter which will again have to do their duties to save their branches from litigations and inquiries which are to follow.

Overall, this was a great time for RBI to look and introspect on the leash it unleashed on Indian banks. Instead, it again passed on the blame on the banks…

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