By: Ahmad Jawed
South Asia comprises of several countries including Afghanistan, Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, and Sri Lanka. The region constitutes around 24 % of the world population and approximately 30 % of the world’s poor lives there. As of this writing, 12.5 million people are tested positive for the virus and India has ranked as the world’s second most infected country. Like any other region, the impact of the pandemic on the economy of this region had begun substantially since it is emergence due to the postponement of international flights and temporarily closure of borders with neighboring countries, the initial impact further propelled after preventive measures such as lockdown of cities, movement controls and closure of supermarkets. As the result of these measures, different sectors- public and private – have been adversely affected, which ultimately slumped both sides of the real economy, aggregate supply and demand.
To contain the economic and financial fallout, which resulted from the pandemic, economic and financial authorities in the region deployed different forms of bold policies mostly in the form of fiscal, monetary, and macro-prudential. Therefore, in this blog, I will try to explain the prudential policy measures that have been implemented in the region by different countries since the emergence of COVID-19. Two sources, the Policy tracker page of IMF and Yale University’s financial stability program page are used as the main sources.
The concept of prudential is not a phenomenon of the 21st century, initially, the term was used in the third quarter of the 20th century. However, after the great financial crisis of 2007/08, prudential policy re-emerged as a policy tool, and financial authorities around the world, particularly financial authorities of G20, more than any other time in history started initiating, developing, and utilizing this policy overwhelmingly in order to mitigate systemic risks in the financial sector of the hyper-interconnected world and to avoid another financial trauma. Unlike the previous crisis, particularly the financial crisis of 2007/08, pandemic originated economic and financial fallout has been addressed quickly and broad-based by different countries of the region. According to the Yale University’s government intervention tracker, which was updated by February 2021, overall 221 policy announcement has been made by fiscal, monetary and regulatory authorities of 6 different countries in the region and out of which, as illustrated in the pie, Prudential Policy (PP) and Monetary Policy (MP) constitute 40% and 37% of policy share respectively and the remaining portion of the pie occupied by Fiscal Policy (FP) announcement. This implies that prudential Policy as equal to other tools played a vital role in terms of stabilizing financial markets during the pandemic.
In the region, two countries, India, the fifth-largest economy in the world with a population of 1,366 billion, and Bangladesh, an emerging middle-income economy and a frontier market in the region, have initiated the highest number of policies since the emergence of the pandemic. In India, 47 prudential announcement has been made by the regulatory authorities followed by Bangladesh with 19 announcements and Pakistan occupied the third place as illustrated in the figure.
The main aim of using prudential policy by the countries in the region during the crisis of COVID -19 was to contain systemic risk across the financial system in general and the banking system in particular. This is because the balance sheet of the financial sector in general and the banking sector, in particular, was hit in several ways due to the economic downturn resulting from the pandemic. The first spillover impact of the pandemic in the banking sector was felt materially in the Non-performing Loan (NPL) component of the balance sheet. Due to the preventive measures taken by the governments of the countries in the region that caused the business to shut down in major cities, the client of the banks defaulted their loans and this, ultimately, raised the portion of NPLs in the balance sheet of the banks. For instance, report states that NPL in the Indian banking sector will rise up to 11 % of gross loans in the next several months. The rise in NPL means a decline in profitability of the banking industry and they require to book a higher amount of provision, which hits the capital of the banking industry harshly. Besides, other components of the balance sheet such as profitability, deposit, demand for loan, and liquidity were affected as well during the crisis. Therefore, without a proper prudential policy measure, observing those shocks, even it is short-term, for the different components of the balance sheet of the banks in the region could be challenging.
What are the Prudential Policy utilized?
- Loan Classification relief and Provision
Loan is one of the components which was effected harshly by the pandemic crisis due to the shatter of business activities. To mitigate such credit risks, International Standards, and domestics banking regulation requires banks to book provision, however, such action amid pandemic is not supported by prudential policy objectives, which affects the capital base of the banking industry severely. Therefore, to address this system-wide issue, promote credit flow and maintain the soundness in the sector, financial regulatory authorities of different countries in the region adopted more or less similar policies. According to the IMF, one of the earlier measures announced and implemented by the Reserve Bank of India (RBI) was forbearance on asset classification of loans extended to MSMEs and real estate construction companies. Moreover, RBI announced a standstill on asset classifications during the loan moratorium period with a 10 percent provisioning requirement, and an extension of the time period for resolution timeline of large accounts under default by 90 days. Furthermore, to increase accessibility of credit and assist mostly affected sector by the pandemic, on May 13, 2020, the government of India announced collateral-free lending program with a hundred percent guarantee, Subordinated debt for affected MSMEs with partial guarantee and partial credit guarantee scheme for public sector banks on borrowings of non-bank financial companies, housing finance companies, and microfinance institutions. Likewise, the Bank of Bangladesh (BB) had announced several measures to mitigate arising from crisis and to maintain the stability of the sector in Bangladesh such as delay non-performing loan classification, relax loan rescheduling policy for NBFIs, waive credit card fees and interests and suspend loan interest payments. Pakistan also took more or less similar measures by increasing the regulatory limit on the extension of credit to SMEs, relaxing the debt burden ratio for consumer loans, allowing banks to defer clients’ payment of principal on loan obligations by one year, and relaxing regulatory criteria for restructured loans for borrowers who require relief beyond the extension of principal repayment for one year. Central bank of Afghanistan had frozen loan classifications at the pre-pandemic cutoff of end-February.
- Capital Buffer Requirement
The trauma of 2007/08 revealed the weaknesses of financial institutions all around the world. Therefore, to build a resilient financial system and mitigate risk arising from any other shocks, external and internal, in the future, financial regulatory authorities had introduced several measurements including capital buffer requirement through different standards. Since then, the requirements have been implemented in several phases. Due to this, at the time of Covid-19 shock, the financial sector in general and the banking sector, in particular, had a resilient capital base. Considering this, the Capital Buffer relaxation policy tool was one of the effective measures adopted by many regulatory authorities around the world including this region. For instance, to support commercial banks in India on observing covid-19 shocks, Reserve Bank of India (RBI) differed the implementation of the last stage of Capital Conservation Buffer (CCB) to April 2021. Pakistan also provided relief to the industry in terms of the capital buffer as the State Bank of Pakistan announced a reduction of 1.5 percent on the capital conservative buffer in the industry. Furthermore, Sir Lanka also provided some relaxation to commercial banks in terms of CCB.
- Dividend Policy and others
Beside the above mentioned policy tools, most of the financial regulatory in the region adopted dividend payment restriction policy conservatively. According to the policy tracking page of IMF, the Central Bank of Sir Lanka, Stat Bank of Pakistan, Bangladesh Bank and Reserve Bank of India have restricted commercial banks either fully or partially to not issue dividend to their shareholders. This was done to maintain optimal level of liquidity in the market to observe the shock. Furthermore, some other measures by authorities have been taken as well such as RBI deferred the implementation of Net Stable Funding Ratio as well as Liquidity Coverage Ratio, DAB (Central Bank of Afghanistan) postponed the implementation of IFRS-9 until June 2021, Bank of Bangladesh raised the ratios of advance to deposit and investment to deposit by 2 percent to facilitate credit to the private sector and improve liquidity and so on.
There were several objectives behind the adoption of prudential policies during the COVID-19 crisis. Firstly, one of the primary reason was to support the business entities who suffered harshly by the pandemic. Therefore, financial regulatory agencies in the region provided relief in terms of loan payments and they have announced easily accessible loan by different sectors. Secondly, resilience, soundness and healthiness of financial industry in general and banking sector in particular was the central discourse of financial regulatory authority’s policy. As such, besides adopting relaxation policy on loan classification and provision, they have supported capital base of banking industry by deferring CCB, restricting dividend payment, postponing the implementation of NSFR and so. By doing so, authorities somehow manage to protect both side of the curve; supplies of fund, banking industry and demand side, business entities and individual. Additionally, countries with strong economic background announced in the region responded immediately like India and banking sector industry in the region performed reasonable during the crisis. Prudential policies as complementary policy for fiscal and monetary policy was reasonably effective on observing shock.