MUMBAI: The Reserve Bank of India (RBI) warned that absence of perceived sovereign guarantees to banks under Prompt Corrective Action would amplify contagion risk of default in banking industry as five state-owned lenders would fall below minimum capital requirements.For stress test purposes if it is assumed that state-owned banks dont have backing of government, then (it) implies that five PSBs which dont meet criterion of Tier-1 capital of 7 per cent would default and start a contagion process on their own, said RBIs Financial Stability Report.For FSR, RBI conducts various kinds of stress tests liquidity, credit and macro-economic developments.
It mostly assesses impact on assumption that state would back government banks.
But for theoretical purposes, it conducted such tests without state backing this time.So now, when we consider hypothetical failure of a trigger bank, losses that would accrue to system would not only be because of trigger bank in consideration, but also because of five PSBs that were automatically triggered, said report.The RBI defended its Prompt Corrective Action framework for state-run banks, a framework that became a major point of contention between regulator and government.
The RBI said capital erosion of 11 banks under PCA showed that solvency losses have reduced.Solvency losses due to a simultaneous failure of 11 PCA banks have declined from Rs 73,500 crore to Rs 34,200 crore (3.1 per cent of total Tier-1 Capital) in past four quarters, and to this extent PCA framework has been successful in reducing systemic footprint of PCA banks, said report.Under PCA, banks that have high bad loans and low capital are barred from setting up new branches, hiring staff and giving big-ticket loans and in some cases, even advance funds to small businesses.