Analysis of the Financial Stability Report

In News 

Recently, Reserve of Bank of India (RBI) released Financial Stability Report (FSR)

Major Highlights of report 

•  Outlook for the global economy
  • It is shrouded by considerable uncertainty because of the war in Europe, front-loaded monetary policy normalisation by central banks in response to persistently high inflation and multiple waves of the COVID-19 pandemic.
• Path of recovery
  • Notwithstanding the challenges from global spillovers, the Indian economy remains on the path of recovery, though inflationary pressures, external spillovers and geopolitical risks warrant careful handling and close monitoring.
• Capital buffers
  • Banks as well as non-banking financial institutions have sufficient capital buffers to withstand shocks.
  • The capital to risk weighted assets ratio (CRAR) of scheduled commercial banks (SCBs) rose to a new high of 16.7 percent, while their gross non-performing asset (GNPA) ratio fell to a six-year low of 5.9 per cent in March 2022.
    • Successive waves of recapitalisation have given banks enough resources to write off most of their bad loans. 
  • NPAs for industrial credit have been reduced even more dramatically, from 23 per cent to 8.4 per cent. 
    • Even after these large write-offs, most banks retain comfortable levels of capital.
  • Macro stress tests for credit risk reveal that SCBs would be able to comply with the minimum capital requirements even under severe stress scenarios.

Issues /Challenges

• The broad aggregates conceal a worrisome picture, raising questions about the role bank credit will play in supporting GDP growth. 
  • The problem is that very little of this credit is going to large-scale industry or for financing investment.
• Decline of Bank credit 
  • Over the last decade, banks have increasingly shifted away from providing credit to industry, favouring instead lending to consumers. 
    • Consequently, the share of industry in total banking credit has declined from 43 per cent in 2010 to 30 per cent in 2020, while that of consumer loans has increased from 19 per cent to 29 per cent. 
• High levels of NPAs
  • Credit doubled within the span of a few years, primarily on the back of lending to large infrastructure projects.
    • Subsequently, many of those loans turned bad, leading to high levels of NPAs on bank balance sheets. 

• Other fundamental problems 
  • There is still no framework that will reduce the risk of private sector investment in infrastructure, certainly not in the critical and highly troubled power sector. 

Conclusion and Way Forward 

• The Report  has given the banking system a reasonably clean bill of health. 
  • It’s a significant achievement, considering the stress of the previous decade, the shock of the pandemic and the associated slowdown of the economy. 

• However, the improvement in banks’ financials is a glass half-full picture. 
  • It is still unclear whether the banking system is healthy enough to provide the sustained credit growth needed for a strong economic recovery.

• Technology has supported the reach of the financial sector and its benefits must be fully harnessed.