Banner

RBI's stress test: Why is it needed & what does it show?

RBI's stress test: Why is it needed & what does it show?

  • Recently, Financial Stability Report (FSR) of the Reserve Bank of India (RBI) highlighted the macro- stress tests conducted by the RBI indicated that the gross non-performing assets (GNPA) ratio of all scheduled commercial banks (SCBS) may improve from 5% in September 2022 to 4.9% by September 2023 under the baseline scenario.

What does the RBI say on the latest stress test?

  • The latest GNPA estimate of 4.9% is based on the assumption that no further regulatory reliefs are given to borrowers under the baseline scenario of the stress test.
  • However, in a medium stress scenario, GNPAs may worsen to 5.8% and to 7.8% in case of a severe stress environment by September 2023.
  • On the capital front, the stress test results revealed that banks are well capitalised and capable of absorbing macroeconomic shocks even in the absence of any further capital infusion by stakeholders

Why does RBI conduct macro-stress tests?

  • It is undertaken on a continuous basis in the Reserve Bank to assess the resilience of the financial system to exceptional but plausible stress events.
  • Stress tests are conducted covering credit risk, interest rate risk and liquidity risk and the resilience of commercial banks in response to these shocks is studied.
  • Using the stress tests, the central bank projects impairment or bad loans and capital ratios over a one-year horizon under a base- line and two adverse - medium and severe - scenarios.
  • The RBI assesses the strength of the banking system through these tests

Assessment of Systemic Risk

  • The Reserve Bank's latest Systemic Risk Survey (SRS) showed that global spillovers, financial market and general risks have increased, while macroeconomic risks have moderated.
  • No change is perceived in institutional risks.
  • Major contributors to rise in global, financial market and general risks
  • Monetary tightening in advanced economies,
  • Tightening of financial conditions,
  • Geopolitical risks,
  • Global growth uncertainty
  • Growing risks from private cryptocurrencies and climate change.
  • The majority of the respondents saw further improvement in credit prospects for the Indian economy and remained confident about the stability of the Indian banking sector.
  • Nearly 90% of the respondents assessed that the prospects of the Indian banking sector are likely to improve or remain unchanged over a one-year horizon.

What are the different types of test scenarios?

  • Generally, RBI considers three scenarios: Baseline and two adverse - medium and severe, for stress tests.
  • The baseline is derived from the steady state forecast values of key macroeconomic variables such as GDP growth, combined fiscal deficit-to- GDP ratio, CPI inflation, weighted average lending rate, exports-to-GDP ratio and current account balance-to- GDP ratio.
  • By design, the adverse scenarios used in the macro stress tests are stringent conservative assessments under hypothetical adverse economic conditions.

Categories