It has been internally discussed to factor in a possibility of being the lender of last resort to NBFCs, mutual funds and microfinance institutions, which are linked to the banking system due to borrowings and investments.
The central bank’s committee on economic capital framework (ECF) on Friday raised the contingency risk buffer (CRB) band in its latest review and contemplated the possibility of having to step in when there’s a crisis.“Although the purchase of assets post-pandemic was confined to public assets, the possibility of private asset purchases in future periods of crisis may not be ruled out,” the committee said in its report to the board of the central bank.
Historically, the RBI’s role as lender of last resort has been limited to commercial banks because the banks accept public deposits.
The lack of funding could lead to a run on the bank and cause the financial system’s collapse.
But the growing interconnectedness among banks, finance companies, and mutual funds in recent years has heightened the risk of contagion during financial crises. The collapse of infrastructure NBFC IL&FS and troubles in mutual fund schemes squeezed many firms, with risk aversion causing dislocation in the financial markets.“The possibility of providing direct liquidity assistance to AIFIs (all India financial institutions), NBFCs, MFIs, corporations, and mutual funds against non-HQLA (high quality liquid assets) collateral during a future crisis may not be ruled out, especially if the risk appetite of the banking system is low or its capital position is strained,” the report added.While the committee’s report to the central bank has factored in the possibility of rescuing the non-banks, the central bank hasn’t decided on such rescues and there is no policy change as of now, said multiple people aware of the line of thinking at RBI. An email to RBI on expanding the lender of last resort (LoLR) policy remit remained unanswered until the publication of this report.
BEYOND SOVEREIGN BONDS
The committee has also raised the possibility of the central bank having to accept as collateral assets that are less than sovereign or state-backed securities. While the central bank may be contemplating the need to possibly expand its role, it may still be providing funds only against the sovereign bonds as collateral, people cited above said. One of the reasons for the shift in the central bank’s approach to funding during a crisis may have also been triggered by a recent suggestion by the International Monetary Fund (IMF).
“To date, RBI crisis measures have been implemented indirectly through banks and the G-secs (government securities or bonds) purchase programme,” IMF said in a report on financial sector assessment. “It should establish ex-ante guidelines to be operationally prepared to accept certain collateral beyond G-secs in crisis times, such as corporate bonds, subject to appropriate haircuts.”
The revised framework also looks at the possibility of RBI providing liquidity assistance in foreign currency to overseas branches of commercial banks.
According to the report, “Given the global operations of SCBs (scheduled commercial banks), the possibility of RBI having to provide liquidity in foreign currency to overseas branches of SCBs in periods of stress, with tightening of counterparty credit lines and widening of spreads, may not be ruled out.”
RBI creates a CRB — or savings for a ‘rainy day’ — to support its role as LoLR. This year, the contingency buffer band has been expanded to “4.5-7.5%” of the central bank’s balance sheet, from “5.5-6.5%” earlier.
The expert committee arrived at CRB after assessing the relatively adverse liquidity shock for the top 10 commercial banks that accounted for 74.75% of total deposits.
