RBI Reports Indian Banking System Still Robust

The strength and profitability of India’s banking system remained robust despite rising bad assets, but underlines the need to raise capital to meet the Basel III norms, according to the Reserve Bank of India’s (RBI) latest assessment.

“A series of stress tests conducted by the Reserve Bank in respect of credit, liquidity and interest rate risks showed that banks remained reasonably resilient. However, under extreme shocks, some banks could face moderate liquidity problems and their profitability could be affected,” India’s central bank concludes in its annual report titled ‘Trends and Progress of Banking in 2011-12’.

The report states that “the financial system of the country remains robust, even though the risk to stability of the system is rising on the back of global and domestic macroeconomic factors.” However, despite the rising impairment of asset quality, “the resilience of the banking sector was manifested in an improvement in the capital base and maintenance of profitability”.

Led by the state-run banks, which collectively account for 70% of the system, the net bad loan assets rose to 1.4% of advances at the end of the most recent fiscal year, up from 1.1% a year ago. “The slippage ratio of the banking system, which showed a declining trend during 2005-08, increased during 2008-12,” the report states.

It adds that higher capital standards, stricter liquidity and leverage ratios and a more cautious approach to risk, are likely to raise funding costs of banks.

RBI, which recently increased the provisioning for restructured loans to 2.75%, and also flagged the rising non-performing asset (NPA) levels, also noted the lack of transparency in information sharing on rising default by borrowers.

On Basel III capital needs, RBI states that banks will have to raise more money to meet higher capital standards, stricter liquidity and leverage ratios and adopt a more cautious approach to risk under the Basel III norms.

The report concludes that the multi-pronged regulatory initiatives undertaken in the areas of prudential and capital requirements of India’s banks, along with a move towards greater convergence in banking regulation globally, are likely to have a major impact on the functioning of banks.

“While banking has become global, banking regulation is national. Therefore, addressing the issue of regulatory arbitrage is at the centre-stage of policy concern,” it commented.

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