Monetary policy calls for robust risk management
The wider autonomy granted to banks is a remarkable feature of the new policy. Additional measures aimed at boosting the resilience and competitiveness of the banking sector include improving credit flow, promoting ease of doing business, simplifying foreign exchange management, enhancing consumer satisfaction, and internationalizing the rupee.
Some significant, long-term additional measures include the rollout of the Expected Credit Loss (ECL) framework, effective from April 1, 2027, which offers a transition period until March 31, 2031. The updated Basel III standards for the capital adequacy ratio will take effect starting April 1, 2027. Additionally, a draft of the Standardised Approach to Credit Risk will be introduced, which is expected to lower overall capital requirements for lending to MSMEs and residential real estate, including home loans.
A tectonic shift is the introduction of risk-based deposit insurance premiums, replacing the current flat rate. The differential pricing of deposit premiums must be well-balanced to ensure that the higher cost of deposit insurance for smaller banks does not exacerbate liquidity and interest rate risk.
Credit growth-centric measures included expanding the scope of capital market lending by providing a framework for banks to finance acquisitions by Indian corporates. It is proposed to remove the regulatory ceiling on lending against listed debt securities. The lending limits for banks against shares have been increased from Rs. 20 lakh to Rs. 1 crore, and for IPOs, the lending limit has been raised from Rs. 10 lakh to Rs. 25 lakh.
Lower Risk Weights
To reduce the cost of providing loans to infrastructure through NBFCs, risk weights will be lowered. Licensing to establish urban cooperative banks, which have been on hold since 2004, will be reopened to expand the sector. Through digital banking services, banks should offer a bouquet of services similar to those provided for the basic savings bank deposit (BSBD) account, eliminating the minimum balance requirement and associated charges. It can allow banks to offer separate ‘digital only deposit accounts’ for the young, tech-savvy target group with low transaction costs. The RBI Ombudsman Scheme will be extended to cover rural cooperative banks.
The expanded operational space places a heavy responsibility on REs to establish internal micro prudential norms and enhance risk management practices. Banks need to analyse their existing detailed operational data to identify current risks, set a revised risk appetite considering internal SWOT analyses to explore new business opportunities, and develop a suitable business model for the next 45 years. They should align their risk appetite with their internal capacity for expansion and avoid taking on an excessive scale of risks.
Forecasting expected credit losses (ECL) may involve incorporating authentic data on the probability of default (PD), loss given default (LGD), and exposure at default (EAD), along with information on special mention accounts (SMA). The glide path until March 31, 2031, provides banks with the transition.
In a nutshell, lenders will be exposed to a significantly higher level of risk. It requires aligning data requirements, strengthening IT infrastructure, upgrading risk management skills, and maintaining higher compliance standards.
