RBI warns against underpricing of risk

RBI warns against underpricing of risk
Hindu Business Line, January 13, 2010, Page 6

Our Bureau, Mumbai,

Banks are once again resorting to sub-PLR short-term lending due to the excess liquidity in the system, said Ms Usha Thorat, Deputy Governor, Reserve Bank of India, while speaking on the sidelines of BANCON, in Mumbai, on Tuesday.

In her address on risk management for the banking sector, Ms Thorat said pricing of risk is important. There is a temptation to under-price risk whenever there is excess liquidity and pressure to generate profits. Pricing below cost can be risky and the risk cost is very often not captured adequately. Moreover, this gives rise to asset price bubbles, she said.

She also cautioned about the large investment by banks into debt-oriented mutual funds.

“MFs have invested large amounts in bank CDs. Banks that have a significant part of their liabilities in the form of CDs have to be sensitive to the rollover risk. Equally, banks that have large investments in MFs have to be sensitive to the liquidity risk in the event of the need for sudden redemption by large investors at the same time. This distortion -whereby MFs are apparently acting as intermediaries in what should otherwise have been intermediated in the interbank market - is something that needs to be addressed,'' Ms Thorat said.

On lending to non-banking finance companies engaged in micro-finance there is a risk that multiple lending and high interest rates could lead to deterioration in asset quality. Therefore, banks should assess the credit quality of these loans by better oversight at the grass root level on a sample basis, she said.

Securitisation of assets by banks during the year ended March 31, 2009, showed a decline of about 30 per cent over the previous year. This might affect the profitability of banks, which have been undertaking securitisation activity as one of the main business lines. However, the securitisation activity may pick up once the retail loan segment starts growing again. RBI would shortly issue guidelines on minimum retention requirement and minimum holding period for securitisable loans, Ms Thorat said.

Banks must also closely monitor the unhedged positions of their borrowers, as it can translate into severe stress on their asset quality.

While introduction of technology in banking has increased the speed and accuracy of service delivery, it has also increased banks' vulnerability to cyber frauds. Banks, therefore, need to put in place appropriate control mechanisms to prevent such frauds, Ms Thorat said.