De-risking risk business: Ensure absorbers before shock, says Vishwanathan

In his keynote address at Business Standard's webinar series, Former deputy governor says good capital buffers are a must

Former Reserve Bank of India (RBI) deputy governor N S Vishwanathan on Friday said “the pandemic has made it clear that risks to the banking sector can emanate from non-economic factors”. Banks will have to keep a close watch on their credit and operational risks, and ensure they have adequate capital buffers, he said in his keynote address at the inaugural session of Business Standard’s webinar series in association with SAS, on 'New Indian Banking Landscape, Post -pandemic’.
 
Vishwanathan also drew attention to the dangers emanating from the enhanced use of digital modes of payments and cautioned banks that they have to think through the way go about their business on this front.
 
In his keynote address, the former RBI deputy governor pointed out that post-pandemic, credit risks lurking in the books of banks and the resultant higher calls for provisioning for bad assets could increase pressure on their margins. And banks should keep their costs-to-income ratios on a tight leash, he said.
 
“The regulatory capital is meant to serve as a buffer against unexpected loss. But the pandemic shows us that unknown risks can be higher,” he noted. Vishwanathan recalled the observation he made in a lecture at
 
XLRI-Jamshedpur on November 2, 2018, on ‘Credit Risk and Bank Capital Regulation’. “Adequate buffers have to be built into the capital maintained to absorb the expected losses which have not been provided for, if and when they materialise.”
 
Vishwanathan’s speech at XLRI had highlighted that higher capital levels in banks have a stabilising effect on the macroeconomy -- that this increases the skin in the game for shareholders, thus potentially leading to better credit appraisal and screening. While raising capital does involve costs, this is by the savings made in the form of potential losses avoided in an averted banking crisis. As the equity component in a bank goes up, the leverage goes down, potentially making the bank safer, thus leading investors in the bank’s equity to demand lower returns on equity. And that depositors, too, may be willing to accept a lower return in view of the greater safety of their funds.
 
In his address on Friday, Vishwanathan was categorical that risks should be taken care of without recourse to the central bank’s forbearance measures. “What we have seen in recent times is that every incident (or crisis) cannot be seen as a one-off”, he said, adding, “It costs less to deal with a crisis before it arises rather than deal with it later.”
 
 On digital banking, he said a collaborative partnership between banks and fintechs is the way forward, but this brings in its share of challenges. A lot of customers can be new to digital banking, and this exposes them and banks to cybersecurity risks. The ability to operate in such an environment will call for both investments in technology and rethink of control systems, in particular when banks outsource key functions as they go about their business.