The poor management of operational risk is at the heart of the Punjab National Bank (PNB) scam, while high credit risks have led to the proliferation of bad debts in the banking system. Financial market participants have been underestimating the risk in the system.
Since 2011, the Reserve Bank of India (RBI) has been conducting a Systemic Risk Survey to capture the views of market participants and all stakeholders on the risks facing the financial system.
The overall risk is segregated, for analysis, into global risk, macroeconomic risk, financial market risk, institutional risk and general risk. The scam at PNB falls within the broad category of institutional risks.
Institutional risks in turn include regulatory risk, risk from asset quality deterioration, risks from additional capital requirements of banks, risks arising out of access to funding by banks, risks from the level of credit growth, cyber risk, operational risk and “other institutional risks”. Of these, the PNB scam is a case of operational risk.
The accompanying chart shows the level of risks in all the categories of institutional risk and the trend in these risks, according to the Systemic Risk Surveys. Risks are rated as very high, high, medium, low and very low.
The last Systemic Risk Survey was carried out in October last year. It showed that market participants felt that the level of operational risk in banks was “medium”. The survey found that operational risks were higher than in the April 2017 survey, which again was higher than in the October 2016 survey, although the level of risk remained “medium”. Note, however, that operational risk was classified as “very low” in April 2015, moved up to “low” in October 2015 and to “medium” in the October 2016 survey. Clearly, market participants felt that operational risk was increasing, although they hesitated to call it “high”.
Risks relating to asset quality, level of credit growth, additional capital requirements and cyber risks were found to be high.
The RBI report says, “According to the survey results, global risks were perceived as medium risks affecting the financial system. The risk perception on macroeconomic conditions and institutional positions have also been categorized in the medium risk category in the current survey. Market risks and other general risk, however, have been perceived to be in the low-risk category in this survey.”
Clearly, the markets were underestimating risk. After the PNB scam, however, it’s very likely that operational risk will now be seen as being either in the “very high” or at least “high” category. Financial market risks are also likely to rise with the hike in bond yields and the return of volatility in the stock markets. A better pricing in of these risks is likely to weigh on the markets.livemint