Banks Vulnerable to Financial Contagion: Reserve Bank

(Reserve Bank of India RBI) may ease norms for infrastructure funding
  • The Reserve Bank of India (RBI) warned markets against “accumulation of vulnerabilities” and “sudden and sharp overshooting in markets”, as the weak global outlook may prolong easy money stance in most advanced economies (AEs).
  • RBI said in its Financial Stability Report (Including Trend and Progress of banking in India 2013-14) :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.
  • RBI added in its report :As of now, financial risk taking had not translated into commensurate economic risk taking
  • On the domestic front, it said that macro-economic vulnerabilities had abated significantly in recent months on the back of (i)improvement in growth outlook(ii) fall in inflation(iii) recovery in the external sector and political stability.
  • However, the central bank noted that growth in the banking business and activity in primary capital markets remained subdued due to moderate investment intentions.
  • Sustaining the turnaround in business sentiment remains contingent on outcomes on the ground.
  • RBI said that 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 deterioration in asset quality.
  • RBI said in its report :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 suggested 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 suggested that the asset quality of banks might improve in the near future under expected positive developments in the macro-economic conditions and banks might also be able to meet expected losses with their existing levels of provisions.
  • However, RBI said: the asset quality of scheduled commercial banks may worsen from the current level if the macro-economic conditions deteriorate drastically and banks are likely to fall short in terms of having sufficient provisions to meet expected losses under adverse macro-economic risk scenarios.
  • Analysis of the inter-connectedness indicated that the size of the inter-bank market in relation to total banking sector assets had been on a steady decline.
  • Contagion analysis with top five most connected banks revealed that the banking system could potentially lose significant portion which is close to 50 per cent of its total Tier-I capital under the joint solvency-liquidity condition in the event of a particular bank triggering a contagion.
  • The RBI also said that 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 promoters 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 impinged upon the banks’ asset quality was corporate leverage and its impact on banks’ balance sheets
  • Particularly ‘double leveraging’ through holding company structures and the pledging of shares by promoters.