Role of Macroprudential Reserves in Addressing Event Risks for NBFCs in India
- Economic and Political Weekly
- 60(22), May 31, 25: p.91-97
The macroprudential approach towards attaining financial stability is being adopted the world over. In India, the Reserve Bank of India has been stressing the importance of forward-looking loan loss provisions to hedge against risks in the banks’ balance sheets, thereby enhancing the resilience of both individual banks as well as the banking system. However, the history of financial crises shows that forward-looking provisions based on “expected losses” cannot absorb tail events. To take care of this concern, the RBI has encouraged banks to make countercyclical (floating) provisions that are not based on expected losses as a prudent measure to strengthen their balance sheets. Such provisions are allowed to be used later in extraordinary and unforeseen circumstances. In this paper, it is shown as to how Indian NBFCs are more susceptible to tail events in the given political economic set-up and, hence, should be encouraged to build up macroprudential reserves as the countercyclical buffer against downside risks. Given the growing importance of NBFCs it is essential that the accounting standard setters and regulators work in tandem to facilitate a more meaningful LLP process for NBFCs. - Reproduced