Mumbai: Indicating that the banking sector is on course to a recovery, the Reserve Bank of India (RBI) on Monday said stress tests suggest further improvement in banks’ asset quality would be made in the new year.

In the baseline scenario, the gross non-performing asset (NPA) ratio may decline from 10.8% in September 2018 to 10.3% in March 2019 and 10.2% in September 2019, RBI said in its biannual Financial Stability Report (FSR). In his foreword to the report, new RBI governor Shaktikanta Das wrote that after a prolonged period of stress, the load of impaired assets was receding, with banks reporting their first half-yearly decline in the gross NPA ratio since September 2015.

The asset quality of banks showed an improvement, with the gross non-performing assets (GNPA) ratio of scheduled commercial banks (SCBs) declining from 11.5% in March 2018 to 10.8% in September 2018. But an industry analysis by RBI shows that stress is rising in the mining, food processing and construction sectors.

Despite projections of a recovery, 18 SCBs, including all public sector banks under the prompt corrective action (PCA) framework, may fail to maintain the required capital adequacy ratio under a two SD (standard deviation) shock to the GNPA ratio, unless capital infusion takes place and banks improve their performance, according to RBI’s analysis. One SD shock equals approximately a two percentage point increase in the GNPA ratio.

The PCA banks are Allahabad Bank, United Bank of India, Corporation Bank, IDBI Bank, UCO Bank, Bank of India, Central Bank of India, Indian Overseas Bank, Oriental Bank of Commerce, Dena Bank and Bank of Maharashtra.

“Notwithstanding the significant costs wrought by the enhanced recognition of asset impairment in Public Sector Banks (PSBs), it appears to have led to a greater discipline in credit assessment, higher sensitivity to market risk and better appreciation of operational risks," Das wrote.

After a prolonged period of stress, the load of impaired assets is receding- Shaktikanta Das

The report pointed out that credit growth of banks improved in September 2018, driven largely by private sector banks. However, the performance of public sector banks witnessed an overall improvement, with credit growth increasing from 5.9% in March 2018 to 9.1% in September 2018 and deposit growth increasing from 3.2% to 5% during the same period.

RBI said there had been a further widening between PCA and non-PCA PSBs: while non-PCA PSBs’ credit growth improved from 9.1% in March 2018 to 13.6% in September 2018 and deposit growth rose from 6.1% to 7.9% during the same period, the PSBs under PCA registered a decline in both credit and deposits.

Interestingly, the central bank also looked at fresh loans turning bad in the same fiscal to assess stress in their incremental loan portfolios. For instance, 11 public sector banks under PCA saw 4.07% of their fresh exposure between April and September 2016 turning bad by the end of September 2016. The numbers have shown a declining trend for PCA banks between 2016-17 and 2017-18, and stood at 2% of the freshly sanctioned portfolio.

“[This is] too high, especially given their constrained capital position and across-the-board superior performance among private financial intermediaries," the report said.

RBI has also conducted a contagion analysis to assess whether the PCA framework has helped in reducing the systemic footprint of PCA banks. For this, the central bank has argued, one needs to do away with the implicit sovereign guarantees enjoyed by PCA banks.

Thus, a systemic impact was estimated by considering the total solvency losses that would be incurred by the banking system if PCA banks failed simultaneously.

“Solvency losses due to a simultaneous failure of 11 PCA banks have declined from 73,500 crore (6.8% of total tier-1 capital) to 34,200 crore (3.1% of total tier-1 capital) in the last four quarters and to this extent the PCA framework has been successful in reducing the systemic footprint of the PCA banks," the Reserve Bank of India said.

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