RBI'S FINANCIAL STABILITY REPORT - OPTIMISM WITH CAUTION

By Ruma Dubey

RBI released a very telling and extremely detailed report – the Financial Stability Report (FSR).  

As the name suggests, this report highlights the risks to financial stability, exposes the vulnerabilities in the financial system and in the face of all this, it gives us insights into how the financial institutions will build the resilience to overcome these challenges.

In the report, while the RBI has begun on a positive note, stating that global financial markets are showing signs of improvement and the political stability within the country has provided impetus to the outlook. But at the same time, it has stated that the banking sector is facing some major challenges and particularly, the Public Sector Banks (PSBs). RBI agreed that though there has been some improvement in the asset quality of scheduled commercial banks (SCBs) since September 2013, the level of gross NPAs as percentage of total gross advances (GNPA ratio) of PSBs was significantly higher as compared to the other bank groups. It has called upon the need to review the Governance structures of PSBs, laying stress on market discipline.

But the underlying good news is that macro stress tests show that the system level capital to risk-weighted assets ratio (CRAR) of SCBs remains well above the regulatory minimum even under adverse macroeconomic conditions. Yet at the same time, it has warned that the lending activity of insurance companies, though currently small scale, may need to be streamlined and monitored under a prudential framework comparable to that for banks to eliminate the possibility of regulatory arbitrage.

A run through the highlights of the report:

• RBI predicts that gross NPAs of banks to remain steady at 4 to 4.1% at end of FY15 v/s 4% which was at end of FY14. But at the same time, RBI has warned that this NPA could rise further to 5.5% of macroeconomic conditions worsen.
• It has assumed a baseline scenario of 5.5% economic growth in FY15 and in case of medium stress, it could drop to 3.6% and 1.7% in case of severe stress. In the same vein, baseline assumption for WPI is at 5.3%, at 7.5% for medium stress and 10.7% for severe stress.
• The results of the Stress report along with the FSR states that though capital adequacy ratio of banks improved to 12.9% in FY14 from 12.7% at end of 9MFY14. RBI expects that under severe stress, CAR could fall to 10.6%.
• The Stress test on sectoral credit risk showed that the Iron and Steel sector is estimated to show the highest NPAs of around 6.7% by end of FY15. The second highest NPA is to come from the construction and engineering industry.
• RBI has estimated that the total capital requirement of PSBs at Rs.4.15 trillion between now and March 2019 when the new international banking capital norms—Basel III norms—are set to be applied in India.
• RBI has stated that around Rs.90,000 crore as total capital will be required by state-owned banks and might have to come from Govt to maintain its current stake in the banks.
• RBI stated that it might consider it desirable to reduce SLR from the current 22.5% as liquidity  capital requirements under Basel III increases gradually.
• Supply side constraints, mainly bottlenecks in food supplies, need to be addressed to complement the RBI’s efforts to contain inflation expectations.

The FSR, overall has an optimistic note, with cautionary warnings. But like the rest of the country, RBI too has pinned a lot hope for growth and development on the Modi sarkar. If Modi and Rajan work together, in tandem, matching step-to-step, India can truly march long ahead.

For more details into RBI’s FSR - http://rbi.org.in/scripts/PublicationReportDetails.aspx?UrlPage=&ID=795