The Reserve Bank of India’s half yearly Financial Stability Report broadly aims to create awareness about the vulnerabilities in the financial system, to inform about the resilience to stress of the financial institutions, to generally serve as a health check on the financial system and to encourage debate on issues relating to development and regulation of the financial sector. The findings reflect the collective assessment of the Sub-Committee of the Financial Stability and Development Council (FSDC) on risks to financial stability.
The findings of the RBI’s eighth Financial Stability Report (FSR) that came out in December 2013 was in the backdrop of a mild positive market reaction to the announcement of tapering in the US Federal Reserves’ bond purchase programme from January 2014.
In contrast, the seventh FSR was released at a time when debate about the appropriateness, timing and pace of imminent exit from unconventional monetary policies by the US was intensifying and the consequent tremors were being felt in financial markets across the globe.
Efforts during the past few months have been directed to make the Indian economy more resilient to the ultimate withdrawal of liquidity from the system and less reliant on unstable external capital for growth.
The commencement of the tapering exercise signalled a calibrated return to normal liquidity and credit conditions in the global markets and also better pricing of risk. This will imply a re-pricing of certain assets with consequent volatility.
Major Highlights
India's external sector has improved with reduction in Current Account Deficit (CAD), expected to be less than 3% of GDP during 2013-14.The delay in tapering allowed India to bring about adjustment in the CAD and build buffers by replenishing its foreign exchange reserves.
Banking system is faced with rising bad loans. Gross non-performing assets (NPAs) in the system will rise to 4.6% by September 2014 from 4.2% in September 2013.
Amount of recast loans touched an all-time high of 10.2% of overall advances as of September 2013.
State-run banks will be the worst-affected.Gross NPAs for public sector banks is likely to be 4.9% by March 2015. Gross NPAs for private banks is pegged at 2.7% in the same period.
Asset quality continues to be a major concern for Scheduled Commercial Banks (SCBs). Gross Non-performing Assets ratio of SCBs and their restructured standard advances ratio have increased.
Five sectors — infrastructure, iron & steel, textiles, aviation and mining — face a high level of stressed advances. These sectors together account for around 24 %of total advances of commercial banks and around 51 %of total stressed advances.
Liquidity pressure is felt by the money market mutual funds (MMMFs) due to their interconnectedness with banks, whenever redemption requirements of banks are large and simultaneous. Regulatory measures are taken to reduce the degree of interconnectedness, whichappear to be successful in reducing the liquidity risk in the system.
India stands committed to the implementation of the global regulatory reforms agenda and hasmade considerable progress on this front.
However, the macro-economic adjustment seems to persist and is far from complete, with major concerns -like persistence of high inflation amidst growth slowdown, fall in domestic savings and high fiscal deficit- confronting the economy.
Macro stress tests on credit risk point out that if the adverse macroeconomic conditions continue, the credit quality of commercial banks could deteriorate further. However, under improved economic environment, the present trend in credit quality may reverse during the second half of 2014.
Apart from macro-economic adjustment, some structural financial reforms are also taking place which can result in some temporary instability. For instance, rupee taking a plunge against dollar ahead of general elections, the Urjit Patel Committee recommending CPI and not WPI to be used as an inflation gauge amongst many other revolutionary ideas, the RBI giving nod for FII participation and market taking to Interest Rate Futures etc., which all are otherwise welcome measures aimed at ushering in a robust banking system. The nine-member Urjit Patel committee, tasked with the idea of evolving a monetary policy framework for the RBI, has suggested that the bank should target four percent retail inflation based on CPI in order to douse inflationary expectations. If this report is adopted by the Governor, the country would have to bid goodbye to any ideas about an immediate drop in interest rates in 2014 as retail inflation currently is just under 10 percent and cost pass-throughs in fuel (diesel, gas, power) and fertiliser are yet to materialise. Finally, certain sectors like telecom, power and oil are most vulnerable to policy risks.
There are also global uncertainties – global recovery still has to become sustainable as it is accompanied by high unemployment levels and IMF is warning of deflation risks; likely cut in Fed bond buys as part of the tapering exercise from current $75 billion to $65billion. Financial Stability Report does claim that the central bank is adequately prepared to sustain the impact of American Federal Reserve's tapering of fiscal stimulus because “external sector risks have been considerably reduced and the effects of tapering on the economy is expected to be limited and short lived.”
The Indian banking industry has been projected to emerge as third largest in world by 2020. Banking assets play a crucial role in economic development of India, accounting for 63% of the nation's financial assets. RBI, which tightly regulates banking assets, is expanding the banking sector through financial inclusion and priority sector lending. This will result in the rural and urban population's greater reach to banking services accompanied by decline in average population per branch with increase in penetration. With the stable and strong banking scenario, the aim of the FSRs, this journey can prove fruitful at the earliest.