Macro-financial risks
The current weak global growth outlook may prolong
easy monetary policy stance in most advanced
economies (AEs). Consequently, low risk premia
may lead to accumulation of vulnerabilities, and
sudden and sharp overshooting in markets cannot
be ruled out. As of now, financial risk taking has not
translated into commensurate economic risk taking.
Against the backdrop of low interest rates in AEs,
portfolio flows to emerging market and developing
economies have been robust, increasing the risk of
reversals on possible adverse growth or financial
market shocks, thus necessitating greater alertness.
On the domestic front, macroeconomic vulnerabilities
have abated significantly in recent months on the
back of improvement in growth outlook, fall in
inflation, recovery in the external sector and political
stability. However, growth in the banking business
and activity in primary capital markets remain
subdued due to moderate investment intentions.
Sustaining the turnaround in business sentiment
remains contingent on outcomes on the ground.
Financial institutions: Developments and stability
The growth of the Indian banking sector moderated
further during 2013-14. Profitability declined on
account of higher provisioning on banks’ delinquent
loans and lacklustre credit growth. The financial
health of urban and rural co-operatives indicated
divergent trends in terms of key indicators. While
urban co-operative banks exhibited improved
performance, the performance of primary
agriculture credit societies and long term rural
credit co-operatives remained a matter of concern
with a further increase in their losses coupled with
a deterioration in asset quality. While the asset
size of the non-banking financial companies (non-deposit taking-systemically important) showed an
expansion, asset quality deteriorated further during
the period of review.
The banking stability indicator suggests that overall
risks to the banking sector remained unchanged
during the first half of 2014-15. In individual
dimensions, though the liquidity position improved
in the system, concerns remain on account of
deterioration in asset quality along with weakened
soundness. The profitability dimension of the
indicator showed an improvement but it remained
sluggish. The stress tests suggest that the asset
quality of banks may improve in the near future
under expected positive developments in the
macroeconomic conditions and banks may also be
able to meet expected losses with their existing
levels of provisions. However, the asset quality of
scheduled commercial banks may worsen from
the current level if the macroeconomic conditions
deteriorate drastically, and banks are likely to fall
short in terms of having sufficient provisions to
meet expected losses under adverse macroeconomic
risk scenarios.
Analysis of the interconnectedness indicates that
the size of the interbank market in relation to total
banking sector assets has been on a steady decline.
However, contagion analysis with top five most
connected banks reveals that the banking system
could potentially lose significant portion of its total
Tier-I capital under the joint solvency-liquidity
condition in the event of a particular bank triggering
a contagion.
Financial sector regulation and infrastructure
While the capital to risk weighted assets ratio (CRAR)
of the scheduled commercial banks at 12.8 per cent
as of September 2014 is satisfactory, going forward,
the banking sector, particularly the public sector banks would require substantial capital to meet
regulatory requirements with respect to additional
capital buffers.
With the increased regulatory focus on segregating
the cases of wilful defaults and ensuring the equity
participation of promoter(s) in the losses leading to
defaults, there is a need for greater transparency
in the process of carrying out a net economic
value impact assessment of large Corporate Debt
Restructuring (CDR) cases. Another aspect that
impinges upon the banks’ asset quality is corporate
leverage and its impact on banks’ balance sheets,
particularly ‘double leveraging’ through holding
company structures and the pledging of shares by
promoters.
Indian stock markets have seen a rapid growth in
recent months. While the retail investor base still
remains comparatively low, India’s stock markets have been attracting substantial amounts of
foreign investments, increasing the risk of reversal.
The Securities and Exchange Board of India has
introduced an additional safety net in the form of
core settlement guarantee fund to mitigate risks
from possible default in settlement of trades and
to strengthen risk management framework in the
domestic capital markets.
With a view to improving participation of actual
users / hedgers and the quality of price discovery
in the market, the Forward Markets Commission
has revised position limits which are linked to
estimated production and imports of the underlying
commodities.
To deal with issues relating to unauthorised deposit
acceptance and financial frauds, the State Level
Coordination Committee (SLCC) mechanism has
been strengthened under the initiative of the
Financial Stability and Development Council (FSDC). |