Taking stock of the contagion risks posed by Infrastructure Leasing and Financial Services (IL&FS) crisis, the Financial Stability Report (FSR) of the Reserve Bank of India (RBI) underlined the need for fine-tuning the oversight framework related to financial conglomerates (FCs) for more timely action.
“A risk-sensitive FC oversight regime where the intrusiveness of oversight of FCs is proportionate to a combination of the size of the entity and the likelihood of an adverse event (say, over a one-year horizon), may make possible remedial measures more timely. Some of the suggestive trigger events for conducting an FC’s assessment may be adverse rating action, unutilised credit lines falling below a certain threshold and bunching of maturing liabilities,” the report said.
The report added that while the current Financial Conglomerate Returns (FINCON) submitted by FCs has an exhaustive list of information set, such data is “backward looking and may not capture emerging risks and vulnerabilities adequately”.
The IL&FS crisis posed serious ramifications for the financial sector with the group having as many as 301 subsidiaries. Financial intermediaries such as banks, insurers and mutual funds were directly or indirectly exposed to the group. The complex structure added to the opaque nature of the group’s financials.
The report highlighted the need to closely monitor conglomerates with such complex inter-group links.
“Complex and camouflaged inter-group linkages through credit support and potency of spillover effects in times of turmoil (through banking sector linkages) are thus becoming important considerations for identifying FCs in the Indian context. In addition, it is also important to have an oversight of groups which are engaged in financial intermediation with significant spillover potential and yet have a significant part of their group revenue coming from non-financial businesses,” the report said.
The central bank also welcomed the market regulator Securities and Exchange Board of India’s (Sebi’s) decision on enhanced disclosure norms for rating agencies.
“Sebi has recently overhauled the disclosures by Credit Rating Agencies (CRAs). The enhanced disclosures pertain to parent/group/government support, liquidity position (including forward looking measures for nonbanks like unutilised credit lines and adequacy of cash flows for servicing maturing debt obligation). Incorporation of such disclosures in the analysis as also periodic discussions with the rating agencies will significantly enrich the quality of the quarterly analysis.”
Besides highlighting the need for closely watching FCs, the report underscored the risk of concentrated exposures for financial intermediaries such as mutual funds (MFs).
“Concentration of exposure in any portfolio has implications for the market stability. A diversified portfolio will be less risky compared to a concentrated portfolio of similar credit,” the report said.
While acknowledging the various safeguards put in place by Sebi, the report said it might be appropriate to consider investor-level concentration limit on the issuer of the debt papers as well.
The report added that the market regulator could consider putting in place a mandatory liquidity limit for the money market and liquid funds.
The RBI re-iterated the need for further inter-regulatory co-ordination to “identify possible regulatory arbitrage opportunities on account of regulatory gaps or perceived and real informational asymmetries amongst the regulators”.
Default impact: The break-up
The RBI’s Financial Stability Report showed that if the top group borrower, or the top-three group borrowers default, the situation could be serious for Indian banks. This indicates the concentration risk that the Indian banking system is exposed to.
Stress tests reveal that the losses could be around 7.6 per cent and 13.6 per cent of the capital at the system level under the assumed scenarios of default by the top-group borrower and by the top two group borrowers, respectively.
“Fourteen banks will not be able to maintain their CRAR (capital adequacy) level at 9 per cent if top three group borrowers fail to meet their payment commitments,” said the December 2018 FSR.