RBI governor warns against complacency amid external headwinds

NEW DELHI: India’s financial system is “very resilient”, but prolonged stability can encourage risk-taking and leave the system vulnerable to a new generation of shocks, Reserve Bank of India governor Sanjay Malhotra said Saturday, flagging risks from high global debt, stretched artificial-intelligence valuations, leverage outside banks and artificial intelligence (AI)-driven cyber threats.

“It's not that I see any imminent signs of stress, but it is because we need to remind ourselves that we need to remain alert to these risks,” Malhotra said at the 5th Kautilya Economic Conclave in New Delhi.

The world has weathered repeated shocks since the 2020 pandemic, while India has enjoyed a long period of stability, backed by strong bank, corporate and household balance sheets. "But I may like to point out that it is these very prolonged periods of stability that can encourage risk taking and leverage. Fading memories of crises can weaken prudence," he said.

Banking and financial stresses can build overnight but take years to resolve, and "they can be very painful", he said. India took more than a decade to clean up the legacy of excessive lending from the early 2000s. “So we cannot afford to become complacent,” he said.

The RBI cannot prevent every shock, whether from the real economy, geopolitics, commodity prices or technological disruption. But it can ensure that the financial system acts as a "shock absorber", through prudent regulation, risk-based supervision, macro-prudential measures, liquidity support including emergency liquidity assistance, and resolution, Malhotra said.

The international order built over decades is also under strain from geopolitical and geo-economic fragmentation. “For central banks, this, therefore, has important implications. We cannot look at price and financial stability in isolation from these developments,” he said.

Five global vulnerabilities

Malhotra identified several risks to global financial stability.

Global debt has risen, maturities have shortened and bond yields have surged. The US 10-year Treasury touched a 24-year high of 5.34% on Thursday. Higher borrowing costs can narrow governments’ fiscal space and worsen debt dynamics, while tighter financial conditions could strain companies’ debt-servicing capacity.

“For banks, sovereign bond losses may weaken their balance-sheets, precisely when the governments face fiscal pressures in supporting troubled banks. Moreover, emerging markets, especially those having high sovereign debt with non-residents, may face capital outflows as the carry trade unwinds,” he said.

The AI investment cycle has supported global financial markets, but a slowdown in these investment or earnings as the cycle matures could trigger a sharp repricing of financial assets, particularly across the AI value chain.

Hedge funds, option sellers, exchange-traded funds and other non-bank financial intermediaries have expanded leverage in equity and bond markets in pursuit of higher returns. “This is of concern especially when equity valuations are stretched,” Malhotra said.

Private credit is another source of vulnerability, signalled by some high-profile defaults, according to the RBI governor. At the same time, the development of sophisticated AI with greater autonomy and problem-solving capabilities has made cyber risk the most immediate concern.

“While each one of these risks individually may not be a matter of concern as of now, the simultaneous occurrence of these shocks can put significant pressure on the global financial architecture,” he said.

India’s buffer

India is also exposed to the West Asia conflict through higher commodity prices and external-sector pressures, but the "economy is navigating this phase from a position of strength", Malhotra said, citing relatively low inflation, the strongest growth among major economies and prudent fiscal consolidation.

The country is also taking steps to strengthen its resilience, including diversifying import sources, increasing self-sufficiency in energy and other critical resources, and building strategic petroleum reserves.

Government bond yields have risen in recent months, but more slowly than those of global peers, reflecting credible monetary policy and fiscal prudence, he said.

A correction in AI-related valuations in advanced markets could also have a positive effect by encouraging capital inflows to India, Malhotra said.

Four priorities

Malhotra outlined four priorities for policymakers: accept that shocks are inevitable and build further resilience; improve scenario analysis to assess new globally interconnected risks and their channels of contagion; strengthen the collection and sharing of data because “[quality] of data will determine quality of risk assessment”; and ensure system-wide resilience that extends beyond banks to markets, payment systems, technology infrastructure providers and critical third parties.

Finally, innovations in AI, tokenization and new forms of financial intermediation must strengthen, rather than fragment, the foundations of trust, he said.