RBI's Financial Stability Report | Current Affairs & Hindu Analysis: Daily, Weekly & Monthly - UPSC PDF Download

Introduction

• The Reserve Bank of India has recently released the 26th issue of the Financial Stability Report. One of the key points highlighted in the report is that the global economy is facing significant challenges with the possibility of recessionary risks.
• This is due to a combination of various factors resulting in tighter financial conditions and increased volatility in financial markets. Despite these challenges, the Indian economy has sound macroeconomic fundamentals and healthy balance sheets in both the financial and non-financial sectors, which are contributing to the stability of the financial system.
• Additionally, there is a growing demand for bank credit and early indications of an investment cycle revival, supported by improved asset quality, return to profitability, and strong capital and liquidity buffers of scheduled commercial banks.
• Furthermore, the gross non-performing ratio (GNPA) of scheduled commercial banks decreased to a seven-year low of 5% in September 2022, while the Net Non-Performing Assets (NNPA) ratio was at a 10-year low of 1.3%, and private banks' NNPA ratio was even lower at below 1%. This report analyzes each of these aspects in detail.

Highlights

• The recent release of the Reserve Bank of India's 26th Financial Stability Report indicates that the global economy is facing significant challenges with the possibility of recession looming large.
• Multiple factors are contributing to financial volatility and tighter financial conditions.

Analysis 

• According to the International Monetary Fund (IMF), the year 2023 is expected to be tougher for the global economy due to several factors such as the ongoing Russia-Ukraine war and the COVID-19 pandemic, which have caused severe turbulence in the main drivers of the world economy, including the US, China, and Europe. Additionally, the emergence of new COVID waves in China and the war have also negatively affected the economy, leading to the possibility of one-third of the world economy going into recession.
• The current global economic situation has resulted in a sharp fall in oil prices, raising concerns about reduced crude demand. Soaring food and energy costs have also caused high rates of inflation in many countries, making it the biggest macroeconomic challenge of the modern era of central banking.
• The US Central Bank's decision to raise interest rates aggressively to fight inflation has also affected countries like India, leading to a depreciation of the Indian rupee against the dollar. This has made borrowing more expensive, causing companies to avoid investing in expanding their businesses.
• Inflation rising across the world and domestic growth slowing down has prompted investors to sell their Indian assets and invest in the US markets for better returns and safety. This lack of growth can trigger investors to pull out their money from an economy, leaving countries, especially poorer ones, with less cash to pay for essential imports such as food and energy.
• Despite facing significant global challenges, the Indian economy is maintaining stability and resilience due to its strong macroeconomic fundamentals, as well as the financial and non-financial sectors' healthy balance sheets. This is contributing to financial system stability.

A brief summary of India's macroeconomic situation:

• India is expected to be one of the fastest-growing major economies in 2022, while other major economies are projected to experience a recession or significant slowdown in their growth. 
• This growth differential gives confidence to investors, reflected in the surge of portfolio flows into India since July 2022. 
• The recent easing of imported inflation pressures, as a result of lowered commodity prices and supply chain pressures, has helped lower India's CPI inflation, which fell below 6% in December 2022. Although India's current account deficit widened in the third quarter of 2022, it may narrow down in 2023 due to easing commodity prices and domestic demand. 
• India's large buffer stocks of food grains ensure food security domestically. The country's foreign exchange reserves of over $562 billion provide a cushion against external shocks, and the strong capital and liquidity buffers of scheduled commercial banks are benefiting from improved asset quality and a return to profitability.

Sound Banking System and its Key Indicators in India

The banking system in India is well-capitalized and provisioned with improved asset quality, which is a key pillar of financial stability. The following are some of the key indicators that highlight the soundness of the banking system in India.

• Gross and Net Non-Performing Assets: The Gross Non-Performing Ratio (GNPA) of scheduled commercial banks reached a seven-year low of 5% in September 2022, while the Net Non-Performing Assets (NNPA) ratio stood at a 10-year low of 1.3%. Private banks' NNPA ratio was below 1%.
• Asset Quality: Asset quality in the banking system improved over the past year, aided by a pickup in economic activity. An improvement in corporate credit performance and upgradation of loans were primary drivers of asset quality improvement.
• Bank Credit Growth: The bank credit growth of commercial banks is at a near nine-year high of 15.5%, the highest since November 1, 2013. A steady and broad-based pick-up in system credit growth despite rising interest rates is a positive aspect.
• Capital and Liquidity Buffers: The consolidated balance sheet of Indian banks saw double-digit growth in 2021-22, after a gap of seven years. The Capital-to-Risk Weighted Assets Ratio (CRAR) of SCBs rose to 16.8% at the end of March 2022. All banks have met the regulatory minimum capital requirement of 11.5% as well as the common equity tier-1 (CET-1) ratio requirement of 8%.
• Profitability: SCBs saw greater profitability in 2021-22 owing to an acceleration in income and a contraction in expenditure. Urban Cooperative Banks (UCBs) saw augmented capital buffers, a decline in GNPA ratio, and improved profitability indicators. The NBFC sector maintained comfortable liquidity buffers, adequate provisioning, and a strong capital position during 2021-22, while asset quality improved.

Financial Stability: Stress tests show SCBs have adequate capital buffers to withstand severe stress scenarios

The results of macro stress tests indicate that Indian scheduled commercial banks (SCBs) have sufficient capital to meet the minimum regulatory requirements even under severe stress scenarios. The system-level capital to risk-weighted assets ratio (CRAR) is projected to remain above the regulatory minimum of 11.5% under baseline, medium, and severe stress scenarios. The CRAR is estimated to be 14.9%, 14.0%, and 13.1% in September 2023, respectively.

• Mutual Funds and Insurance Companies: Stress tests show no breach in limits for open-ended debt mutual funds and solvency ratio for insurance companies remained above the minimum level
• Stress tests conducted for open-ended debt mutual funds revealed no breach in limits concerning interest rate, credit, and liquidity risks. Furthermore, the consolidated solvency ratio of both life and non-life insurance companies remained above the prescribed minimum level. Solvency ratio is a measure of a company's ability to meet its long-term debts and obligations.