The Central Bank’s COVID Response | Finding balance between financial sector stability and credit growth

Key Takeaways

  • Steady credit flow to the real economy is imperative for the post-COVID-19 recovery. In order to facilitate this, the Central Bank needs to ensure financial institutes have both the capacity and the willingness to lend.
  • Financial institutions were on a weaker footing even before the COVID crisis due to the Basel III capitalization requirements, the deterioration in asset quality, and dwindling profitability due to macro factors. Therefore, the risk appetite of the financial institutes at the moment is low.
  • The reduction in policy interest rates beyond a certain point may not generate appreciable expansion in credit in the economy as the financial institutes’ risk appetite would not improve in a state of crisis.
  • The credit guarantee scheme is a step in the right direction to improve the risk appetite but its success depends on whether the banks can recover the value of the guarantee in a timely manner in case of defaults.
  • The net outcome of the CBSL actions have far more intricate dynamics and risk implications for the system therefore, looking forward, it is important to strike a balance between financial stability and credit growth.