MBF 2025-wl-6255-Role of Macroprudential Reserves in Addressing Event Risks for NBFCs in India

Across the globe, national authorities have adopted macroprudential approach to financial stability. In India also, the Reserve Bank of India (RBI) has been stressing on the importance of forward-looking loan loss provisions to hedge against risks in the banks’ balance sheet, 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 not based on “expected losses” but as a prudent measure to strengthen their balance sheets. Such provisions are allowed to be used later for making specific provisions in extraordinary circumstances. In this paper, we have shown how Indian non-bank finance companies (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 in India’s financial landscape and critical role they are playing in serving India’s underserved and unbanked areas, it is absolutely essential that the accounting standard setters and regulators work in tandem to facilitate a more meaningful loan loss provisioning process for NBFCs.