RBI lens on bank business models for underlying risks

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With asset quality and capital adequacy of the banking system seeming comfortable at a systemic level, the banking regulator’s focus has increasingly shifted gears to assessing the long-term stability and sustainability of business models adopted by banks.

In fact, in the recently concluded financial stability review process internally conducted by the central bank, business models of banks were analysed extensively on these parameters.

Prioritising Filesadmin.co models

According to sources, the focus on business models has increased post pandemic and has assumed greater emphasis post the repo rate hikes since May 2022. Also, with banks realigning their businesses models more towards retail banking in the last 4-5, the needs for critically examining the sustainability of some of these businesses is seen important.

“The objective of this exercise is to skim for underlying risks in the business models and take corrective actions so that any mishaps can be averted whether internally at a bank or at a systematic level,” said a highly placed source aware of the matter.

These could be portfolio concentration risks, risk of product mis-pricing, or technology or internal audit related deficiencies. Check are being run on the business models of banks to ensure that there are no ALM or asset liability management mismatches, unreasonable exuberance in product pricing and growth is comfortable to maintain judicious credit-deposit ratio.

Email sent to RBI seeking confirmation of the above matter remained unanswered till press time.

“Increasingly banks are raising deposits of short-tenure maturity, but short-tenure deposits cannot be relied upon extensively to cover long-term loan books. Also, banks shouldn’t be excessively focussing on short-tenure loan assets because over a period it can result in ALM issues. These are some of the aspects that the regulator is looking into,” said a senior banker with knowledge of the review process. That said, the Reserve Bank of India principally does not involve itself in the overall operations and functioning of banks.

Keeping them in the know

It is gathered from sources that outcome of these review processes is constantly communicated to banks in closed room discussions.

However, in certain cases where the extent of corrective actions required may be significant or the regulatory discomfort with certain practices are high, these observations have been flagged off the annual inspection report for FY23. These reports too are private communication between the regulator and banks, except in certain cases such as underproviding for loan where the impact of these observations can have a material effect on the financials of a bank.

Scanning the business

– RBI increases focus on assessing the long-term stability and sustainability of banks’ business models

– Exercise has assumed more importance post pandemic, repo rate hikes and increasing proportion of retail loans

– High focus on ALM practices and CD ratios of banks

– Seen as early stress detection process to averted failures a bank and/or systematic level

– Potential risks include portfolio concentration, product mis-pricing, or technology or internal audit related deficiencies