RBI is using lessons from 2008 financial crisis to handle the Covid-19 lockdown effect on the economy

• The Reserve Bank of India’s (RBI) measures to increase liquidity in the economy as reminiscent of lessons learnt during the 2008 global financial crisis.
• Rajosik Banerjee, partner and head of financial risk management at KPMG in India told Business Insider how it’s important to stay afloat during the pandemic with short-term measures.
• The aim is to offset the risk aversion of banks to extend credit in the face of the economic downturn, similar to what was seen in the aftermath of the 2008 global financial crisis.

The global financial crisis of 2008 was the biggest economic crash of the 21st century — that is until Coronavirus came along. To offset some of the damage, the Reserve Bank of India (RBI) introduced a slew of measures, many of which reflect the lessons learnt from the 2008 financial crisis.

At the time, the impact was less severe on Indian markets because the country’s banks had limited exposure to failed and stressed international financial institutions, caught in the mix. However, when it comes to the impact of Coronavirus — India is as much on the frontline of the economic crisis as any other country.

During the 2008 credit crisis, the yield curve — which shows the relation between the rate of interest and economic activity — was inverted. This means the cost of short-term survival then was higher than in the long term.

“The learning from the past credit crisis suggests that it is important to stay afloat during the pandemic in the short term with relief measures, else the pandemic will trigger additional delinquencies and NPA [non-performing assets],” Rajosik Banerjee, partner and head of financial risk management at KPMG in India told Business Insider.

How does delaying payments on loans help the economy?
The RBI’s decision to offer a 3-month deferment on loan payments keeps the NPAs from building up during the lockdown period. It also relieves some of the pressure that would have otherwise been on the financial services sector — pressure that could create a contagion risk for the corporate sector, according to Banerjee.

“The deferral here would mean that borrowers get to hold on to liquidity for the next quarter and deploy the money to maintain existing business requirements. Thus, deferring transmission of financial stress into the real economy,” he explained. However, Banerjee also pointed out that the temporary fix only works if the spread of Coronavirus can be contained.

What happens if Coronavirus continues to spread — and if it doesn’t?
If Coronavirus continues to spread and the number of cases continues to increase, NPAs could pile up by the time the lockdown finally ends. The collective burden of those NPAs could be harsh conditions for Indian banks.

“The regulator and the government should continue to monitor this closely,” advised Banerjee.

Should India’s lockdown end in a timely manner — which seems unlikely with most states appealing for an extension, like in Telangana — RBI’s enhanced liquidity measures will bear fruit.

The reduction in the cash reserve ratio (CRR), increase the marginal standing facility (MSF), cutting of repo and reverse repo rates, and the auctioning of targeted long term repo operations will release additional liquidity of ₹3.74 crore into the market.

“Companies would be the expected beneficiaries. MSMEs and SMEs too will benefit from the reduction in the spread, hence it will have a positive impact on the cost,” said Banerjee.

The aim is to offset the risk aversion of banks to extend credit in the face of the economic downturn, similar to what was seen in the aftermath of the 2008 global financial crisis.

He anticipates that the credit growth will be gradual considering most clients are still in a lockdown mode and inventory movement isn’t optimum. “We should see the benefits rolling in once things open post lockdown,” he explained.

For some borrowers, it may still lead to long term deterioration in credit risk. A uniform restructuring plan may not be ideal but some level of standardisation will help. According to Banerjee, the RBI should consider issuing separate guidance for that.

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