Banking system getting back to health as NPAs on the decline: RBI report

“After a prolonged period of stress, the banking sector appears to be on course to recovery as the load of impaired assets recedes” Shaktikanta Das, RBI Governor
The bad assets problem of the banking sector in the country is receding for the first time since 2015, according to the bi-annual financial stability report (FSR) for December, published by the Reserve Bank of India (RBI) on Monday. But, the non-performing assets (NPAs) are still too high for comfort.

The banks showed an overall improvement with their gross NPA (GNPA) ratio declining from 11.5 per cent in March 2018 to 10.8 per cent in September 2018. However, stress was still on the rise in mining, food processing, and the construction sectors.

“The banking sector appears to be on course to recovery as the load of impaired assets recedes. The first half-yearly decline in the gross NPA ratio since September 2015 and the improving provision coverage ratio, being positive signals,” said RBI Governor Shaktikanta Das in the foreword to the report.

Stress-test results showed banks had liquidity and should be able to withstand pressure, while there appeared to be greater discipline in credit assessment, higher sensitivity to market risk, and better appreciation of operational risks, Das said. The Insolvency and Bankruptcy Code had brought a paradigm shift, and had helped bringing in the much-needed discipline in the credit culture of the country, even as some of the resolutions lag behind the envisaged timelines.

“A time-bound resolution of impaired assets will go a long way in unclogging the credit pipeline, thus improving the allocative efficiency in the economy,” Das said.

While the system seemed healthy at present, there were risks nevertheless. 

“Among the institutional risks, the asset quality deterioration of banks, risk on account of additional capital requirement, and cyber risk continued to be perceived as high-risk factors,” the report said. On day-to-day liquidity requirements, 49 out of the 54 banks were found to be resilient in a scenario of assumed sudden and unexpected withdrawals of around 10 per cent of deposits along with the utilisation of 75 per cent of their committed credit lines.

However, banks under the prompt corrective action (PCA) framework needed capital to protect themselves from severe shocks. 

For example, if the gross NPA ratio of 54 banks moves up from 10.9 per cent to 14.9 per cent, the system-level capital adequacy ratio (CAR) will decline from 13.4 per cent to 11.1 cent, and the core capital will decline from 11.2 per cent to 9 per cent for these banks. 

However, 18 banks, including all 11 under the PCA framework, “might fail to maintain the required CRAR (capital to risk weighted assets ratio),” if the gross NPA ratio increased by 4 percentage points. These 18 banks had a share of 31.7 per cent of total assets of all banks.

“As many as eight public sector banks under the PCA framework may have a CRAR below the minimum regulatory level of 9 per cent by March 2019 without taking into account any further planned recapitalisation by the government,” the report noted.

The banks under the PCA are now less risky, as the restricted framework had managed to reduce their systemic footprint.

“Lending and other restrictions imposed on the banks under the PCA framework have led to a reduced impact on the system through connectivity. This has reduced the contagion losses incurred by the banking system in case of the PCA banks’ failure,” the report said, justifying the RBI’s resolve to continue with the restrictive PCA framework.

Nevertheless, there was capital infusion in banks, leading to an improved credit expansion in September 2018, driven largely by private sector banks. Non-banking financial companies (NBFC) had also increased their lending activities, while “the relative proportion of domestic bank and non-bank resources was almost evenly matched.”

Mutual funds (MFs) had emerged as one of the largest financial intermediaries in providing funds. However, the FSR sounded caution on the sector, considering the risk of credit concentration, as was evident from the recent Infrastructure Leasing & Financial Services saga. MFs had about Rs 6,500 crore of the IL&FS group’s exposure out of a total debt of around Rs 90,000 crore.

The degree of interconnectedness in the banking system had been declining slowly over the past five years. 

MFs were the largest provider of liquidity in the system, with their gross receivables being around 36.5 per cent of their average asset under management. The gross receivables were around Rs 8.34 trillion. The top three recipients of their funds were banks, followed by NBFCs and housing finance companies.

  • Key highlights from the Financial Stability Report
  • Indian banks’ bad debt fall for the first time since 2015
  • Banks are liquid and able to withstand sudden withdrawal of deposits
  • Lenders under PCA need urgent capital to maintain minimum requirement
  • PCA bank induced system reduces risks
  • Mutual funds are the largest net provider of liquidity in the system

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