A systemic risk survey (SRS), the eighteenth in the series, was conducted during April-May 2020 to capture the perceptions of experts, including market participants, on the major risks faced by the financial system. According to the survey results, all major risk groups viz., global risks, risk perception on macroeconomic conditions, financial market risks and institutional positions were perceived as ‘high’ risks affecting the financial system (Figure 1).

Within global risks, global growth was categorised as a ‘very high’ risk. Within the macroeconomic risks group, domestic growth and the fiscal deficit were perceived to be in the ‘very high’ risk category, while risks on account of reversal of FIIs/slowdown in FDI, corporate sector vulnerabilities, collapsing real estate prices and household savings were perceived to be in the ‘high risk’ category. Among the institutional risks, the risks on account of asset quality deterioration and level of credit growth were perceived as ‘high risk’ factors. Cyber risk appeared in the ‘high risk’ category for the first time since the inception of the survey (Figure 2).

Participants opined that the effects of COVID-19 are likely to remain for 3-5 years and may impact the quality of credit in the books of banks, the general risk taking ability of entrepreneurs, investments in capital markets and real estate, and the saving pattern of households. All these could have an impact on domestic financial stability.

The MSME sector is affected because of lack of cash flows. Low demand, lack of manpower, stuck working capital and lack of capital may lead to further stress on employment. Real estate prices and cash flows on commercial real estate can undergo a major structural correction due to change in working patterns, which will lead to further pressure on real estate developers and lending. Potential margin compression in corporate bonds was seen as increasing leverage, leading to negative impact on credit metrics and consequent rating downgrade that can result in difficulties for refinancing of loans and raising capital.

In the financial sector, the existing stock of non-performing assets in the banking system and bankers’ risk aversion remain big worries and impediments to economic growth. Despite measures taken by the Reserve Bank, transmission of liquidity and rate actions is still slow. Coupled with continued risk aversion, the flow of credit to the productive sectors (including NBFC & HFC) remains a challenge, Given that financial services are an integral and important constituent of the credit market, many participants opined that support from RBI would be important in the current environment.

About 56 per cent of the respondents opined that the prospects of Indian banking sector are going to deteriorate considerably in the next one year, as earnings of the banking industry may be negatively impacted due to slow recovery post lockdown, lower net interest margins, elevated asset quality concerns and a possible increase in provisioning requirements. About 36 per cent of the respondents felt that the prospects are going to deteriorate only marginally (Chart 1).

Majority of the participants in the current round of the survey expect a very-high probability of occurrence of a high impact event in the global financial system in the short term (upto 1 year). In the medium term (1 to 3 years) majority of the participants in the current round of the survey assign a ‘medium’ probability to the occurrence of a high impact event in the global financial system. In the Indian financial system, the participants opined that there is a high probability of occurrence of a high impact event in the short-term but the probability of such an occurrence in the medium term (1 to 3 years) is medium. About 70 per cent of the respondents were not very confident in the stability of the global financial system (Chart 2).

Majority of the respondents were of the view that the demand for credit in the next three months would decrease considerably. Average credit quality is also expected to deteriorate considerably in the next three months (Chart 3).

COVID-19 pandemic: Effects and economic recovery

Respondents opined that while most sectors face sizeable and immediate revenue losses, the adverse impact is seen in sectors where consumption spending is discretionary in nature. The survey results point to 5 sectors which are adversely affected by the COVID-19 pandemic (Table 1). Within the tourism sector, about 90 per cent of the respondents mention that the prospects of recovery within the sector in the next 6 months appear bleak. The aviation sector appears to be a close second, with about 85 per cent of the respondents categorising the future prospects as bleak.

Participants were asked to rank the major financial stability concerns arising out of COVID-19 going forward (Table 2). Supply chain disruptions and decreasing consumer spending/confidence were the top two concerns of the participants, followed by worries about a global recession and the financial impact of liquidity/capital on operations.

About 63 per cent of the respondents predicted that the economic recovery post COVID-19 is likely to be U-shaped i.e., immediate fall followed by a longer period to recover (Chart 4).

72 per cent of the respondents opined that in trade terms going forward, localisation will take precedence over globalisation and more regional trade pacts would emerge and be preferred (remaining 25 per cent) (Chart 5).