5 minute read 24 May 2020
How to mitigate liquidity and interest rate risks

What steps can banks and NBFCs take to mitigate their liquidity and interest rate risks?

By

Pratik Shah

EY India, Partner – Financial Services Risk Management Consulting

With over 20 years of experience across governance, risk and compliance, Pratik is enabling leaders across various global banks and financial institutions formulate strategies and build efficiencies.

5 minute read 24 May 2020

The threat of COVID-19 makes it important to evaluate risk caused by the crisis and the steps banks and NBFCs should take to mitigate risks.

The COVID-19 outbreak is causing an unprecedented crisis with direct impact on public health, social life and the economy across the world. One of the fallouts would be heightened credit and profitability pressure on an already stressed financial system in the country.

Collections and Credit Monitoring Mobilization in Retail Lending: Response to COVID-19

To mitigate the burden on debt-servicing, the Reserve Bank of India (RBI) has allowed the lenders to grant a moratorium of three months on payment of all instalments falling due between 1 March 2020 and 31 May 2020. The intention is to shift the repayment dates by three months to release the cash flow for the consumers who are impacted by the current situation.

There are many unanswered questions on how and when the COVID crisis will get over. Taking a view of the impact on retail and microfinance business and breaks up the outlook into the immediate future, the medium range view and a longer term, keeping a strong action bias for mobilizing credit monitoring and collections capability with an aim to minimize the impact on banks and NBFCs.

While the uncertainties are looming large and it will not be an easy period, breaking the period into tranches can help evolve and focus as banks and NBFCs progress.

Today or now, is clearly about keeping the show on the road, implementing moratorium and assessing the impact.

Tomorrow, or the next two months, is about looking beyond the current shocks to prepare for containing the impact on loss, capital and profitability. It is about deep diving into portfolio, using analytics to enhance collections efficiency and enabling digital payment and digital contact with the customers.

Beyond is about building resilience to withstand current and future shocks. Some of the ways of driving this are creating data-driven organizations, digitizing customer and process journeys (like collections management, frontline payment), setting up Early Warning Systems (EWS), building new models and analytics capabilities and leveraging the power of alternate data.

Are Indian banks and NBFCs ready to absorb COVID-19 impact?

The Indian financial services sector had just started seeing a gradual recovery from slow credit off-take and increased distressed assets, when fresh challenges have emerged. Recently, financial services non-performing assets (NPAs) declined from its peak of over 10% of advances and improved their profitability.

However, soon afterwards, the telecom AGR (adjusted gross revenue) liability and private sector bank stress impacted market sentiment and caused loss in market valuations. The Covid-19 pandemic was like a bolt from the blue. The sudden lockdown experienced by businesses ranging from airlines and hotels to automobiles could mean heightened credit risk for companies in these sectors even after the three-week lockdown imposed by authorities is lifted.

Re-ignition of business post the lockdown is lifted would be a major challenge for especially corporate and SME borrowers. This would have a downstream stress on repayment and credit off-take for the financial services sector.  With this backdrop, it is important to analyze how prepared the financial services sector is to weather this unprecedented storm, which is playing out in full force globally as we analyze current exposure of banks and NBFCs.

Current exposure of banks and NBFC

If the impact of Covid-19 pandemic prolongs, banks may have to deploy more capital for provisioning and may create a huge impact on NBFCs and MFIs due to additional higher provisions. This may further impact their exposure to NBFCs, and they may end up losing money causing significant impact on financial institutions.

Considering current capital and liquidity position of financial institutions, they have to be extra cautious for new loan book and have to include five main factors in amended credit lending policy.

Realigning liquidity and interest rates strategy

Re-aligning Liquidity & Interest Rate strategy for Banks & NBFCs post  COVID-19

Given the Covid-19 outbreak and its consequent impact on banks and NBFCs, Moody's Investors Service changed its outlook for the Indian banking system to ‘negative’ from ‘stable’ due to the following:

  • Deterioration in financial institutions’ asset quality and liquidity.
  • Growing risk aversion in the system following stress on a prominent private sector bank causing funding and liquidity pressure.
  • Credit flow to the economy already remains severely hampered because of severe liquidity constraints in the bank and non-bank financial sectors.

While the Monetary Policy Committee of the RBI has taken several measures to enhance liquidity there are still multiple risk factors looming such as:

  • Near term liquidity mismatches
  • Stress on liquidity coverage ratio (LCR)
  • Funding risk             
  • Intraday liquidity

Therefore, it becomes critical that banks and NBFCs have to prepare for liquidity stress and interest rate changes, manoeuvre dynamically through current and potentially pro-longed volatility and uncertainty due to COVID-19. The stress testing exercise need be leveraged as a proactive tool for driving strategic action and survival by the senior management and not just mere academic exercise. If these exercises are weak or inaccurate in predicting the impact while the damage has already occurred, it may need a major overhaul.

Download the PDFs:

  1. Are Indian banks and NBFCs ready to absorb COVID-19 impact?
  2. Collections and Credit Monitoring Mobilization in Retail Lending: Response to COVID-19
  3. Re-aligning Liquidity & Interest Rate strategy for Banks & NBFCs post COVID-19

Summary

Banks and NBFCs will have to prepare for liquidity stress and interest rate changes, maneuver dynamically through current and potentially pro-longed volatility and uncertainty due to COVID-19.

About this article

By

Pratik Shah

EY India, Partner – Financial Services Risk Management Consulting

With over 20 years of experience across governance, risk and compliance, Pratik is enabling leaders across various global banks and financial institutions formulate strategies and build efficiencies.