Stress in banking sector on the rise, says Reserve Bank of India

The Reserve Bank of India (RBI) warned of difficult times for the country’s banking sector if macroeconomic conditions do not improve going forward. Bad loans went up while household financial savings have reduced in the first six months (April-September) of this fiscal, according to the Financial Stability Report released by the RBI on Monday.

“Macro stress tests on credit risk suggest that if the adverse macroeconomic conditions persist, the credit quality of commercial banks could deteriorate further,” said the RBI in the report.

In worse case scenario, the gross non-performing assets (GNPAs) ratio could worsen to 7% by March 2015 from 4.2% at September-end. In case the situation improves, GNPA ratio could come at 4.4% by March 2015. However, even under favourable macroeconomic conditions, the GNPA ratio is expected to increase to 4.6% by September 2014.

“The risks to the banking sector have further increased during the past half-year. All major risk dimensions captured in the banking stability indicator show increase in vulnerabilities in the banking sector,” said the RBI.

The RBI said that the strain on banks’ asset quality continues to be a major concern. Sectors like infrastructure, iron and steel, aviation, textiles and mining continue to dent banks’ asset quality.

The RBI said current economic slowdown – both global and domestic -- persistent policy logjams, delayed project clearances and deficiencies in credit appraisal have caused deterioration in asset quality. Excess capacities due to aggressive expansion by corporate houses during the boom phase was also to be blamed.

The total stressed advances ratio rose significantly to 10.2% of total credit at September-end from 9.2% as on March. The largest contribution to stressed advances came from public sector banks, said the RBI. It pointed out that the number of banks that could become distressed even if one bank comes under fire has risen sharply since August 2013. Also, failure of a major corporate or group could trigger a contagion in the banking system due to exposures to a large cumber of banks.

The RBI said that high inflation continued to impact financial savings of Indian households. “A fall in savings has widened the saving-investment gap, increasing the economy’s dependence on external capital,” said the RBI. On the other hand, savings were directed to non-financial assets like real estate that gave households better returns than bank deposits. 

The tapering of quantitative easing by the US Fed, which is slated to begin from January, will not have much impact on India, said the RBI. “India utilised the delay in tapering to bring about adjustment in the current account deficit and built buffers by replenishing its foreign exchange reserves. Consequently, external sector risks have been considerably reduced” and taper’s impact... “is expected to be limited and short-lived.”