Govt's grip on state-run banks cuts RBI's risk
The
Reserve Bank of India
has said that the government's ownership of
public sector banks
(PSBs) makes it easier to manage risk, reducing the central bank's exposure to potential losses. In a recent report on its economic capital framework, the RBI said this ownership justifies lower
capital buffers
for these lenders when it comes to providing emergency
liquidity
assistance (ELA).
The central
bank
said that government-owned banks are seen as safer, as the government acts like a parent company with deep financial resources. 'The present review proposes to account for the inherent strength due to sovereign ownership in case of PSBs, while assessing the recovery rates,' the report stated. This strength makes public banks less risky for the RBI to support and reduces the capital the central bank needs to hold against such risks.
The RBI said its stance is backed by the government's actions in the past. 'Govt had infused an amount of more than Rs 3.1 lakh crore as capital during the period since RBI's asset quality review,' it said. This capital injection has had a visible impact on the health of the banking sector.
Non-performing assets
(NPAs) have dropped significantly—from 9.3% in March 2019 (12.6% for PSBs) to 2.6% in September 2024 (3.3% for PSBs).
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by Taboola
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Previously, the RBI's expert committee had assumed a uniform recovery rate of 80% on ELA against non-high quality liquid asset collateral for both public and private sector banks. However, the current review moves away from that view.
This shift in approach means that the RBI now expects smaller losses when supporting PSBs. 'Accordingly, the potential LOLR losses of RBI for the quantum of loans extended to PSBs have been assumed to be lower (10%) as compared to private sector banks (20%),' the report said. This effectively halves the loss estimate for PSBs because of the implicit state guarantee.
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Stress-test results in the report show that even under financial strain, the RBI would face potential losses of only around 3% of its balance sheet. This assumes recovery rates of 90% for PSBs and 80% for private banks.
The report also highlighted possible risks from the global operations of scheduled commercial banks. It said that in periods of financial stress, when credit lines tighten and spreads widen, the RBI might need to provide foreign currency liquidity to overseas branches of Indian lenders. This possibility 'may not be ruled out', the report said.
By taking into account the backing provided by the government, the RBI is adjusting how it measures and prepares for financial risk in the banking system. This has allowed the central bank to assume lower losses on public banks, which in turn reduces the amount of capital it needs to hold in reserve—freeing up resources while still preparing for emergencies.
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