The Reserve Bank of India recently released its latest Financial Stability Report (FSR).
What is the FSR?
The Financial Stability Report (FSR) is published twice each year by the RBI.
It presents an assessment of the health of the financial system.
The FSR primarily looks at questions like the following:
Do Indian banks (both public and private) have enough capital to run their operations?
Are the levels of bad loans (or non-performing assets) within manageable limits?
Are different sectors of the economy able to get credit (or new loans) for economic activity?
What is the significance of the FSR?
The data and information in the FSR allows the RBI to assess the state of the domestic economy.
The FSR also allows the RBI to assess the macro-financial risks in the economy.
As part of the FSR, the RBI also conducts “stress tests.”
This is to figure out what might happen to the health of the banking system if the broader economy worsens.
Similarly, it also tries to assess how factors outside India might affect the domestic economy.
E.g. the crude oil prices or the interest rates prevailing in other countries
Each FSR also contains the results of something called the Systemic Risk Surveys.
What are the highlights of the recent report?
GNPAs - In June 2020, the FSR had noted that Gross NPAs (GNPAs) could rise from 8.5% (of gross loans and advances) at the end of March 2020 to a two-decade high of 14.7% by March 2021.
The recent FSR has found that the actual level of bad loans as of March 2021 is just 7.5%.
However, the GNPA ratio of Scheduled Commercial Banks may increase from 7.48% in March 2021 to 9.80% by March 2022 under the baseline scenario.
Under a severe stress scenario, it could increase to 11.22%, as shown by “macro-stress tests” for credit risk.
So, the relief provided by the RBI in 2020 has contained the number of Indian firms that openly defaulted on their loan repayment.
But things could get worse, especially for the small firms (or MSMEs).
[The relief measures include cheap credit, moratoriums and facilities to restructure existing loans]
Regulatory relief and NPA - A clear picture of NPAs will emerge only when the regulatory relief provided by the RBI is taken away.
But it is not always clear when a central bank should pull back such regulatory relief.
Historical experience shows that credit losses remain elevated for several years after recessions end.
Indeed, in EMEs [Emerging Market Economies], NPAs typically peak 6 to 8 quarters after the onset of a severe recession.
The longer the blanket support is continued, the higher the risk.
Because providing excess regulatory relief might help inherently inefficient firms too.
On the other hand, banks need sufficient buffers to absorb losses along the entire path to full recovery.
So, support measures cannot be phased out before firms’ cash flows recover.
Credit growth - At less than 6%, the overall rate of credit growth in commercial banks is quite dismal.
What is particularly worrisome is the negligible growth rate in wholesale credit [refers to loans worth Rs 5 crore or more].
The rate of growth for retail loans (loans to individuals) had become much better in comparison.
Notably, there was a sharp fall in credit growth much before the Covid pandemic hit India.
It points to a considerable weakness in demand even before the pandemic.
This, in turn, suggests that recovery in credit growth may take longer than usual.
Systemic Risk Survey (SRS) - The FSR also published the results of the latest round (April 2021) of the Systemic Risk Survey (SRS).
It reflects upon the major risks faced by the Indian financial system.
The risks are broadly classified into five categories - global, macroeconomic, financial market, institutional and general.
The overall risk perception is “medium.”
However, there were several factors on which experts expected a worrying picture than the one provided in the January 2021 FSR.
