What does RBI's Financial Stability Report reveal?

Stress tests show that gross NPAs may fall further to 4.9% by September 2023.
Stress tests show that gross NPAs may fall further to 4.9% by September 2023.

Summary

The stress tests in RBI’s Financial Stability Report showed that banks are capable of absorbing shocks even under adverse situations.

Gross bad loans at banks have been declining and hit a seven-year low of 5% in September, shows the RBI’s Financial Stability Report (FSR). Its stress tests showed that banks are capable of absorbing shocks even under adverse situations. Mint analyses the report.

What does the central bank’s FSR state?

While the economy is facing global headwinds, macroeconomic fundamentals and healthy balance sheets provide strength to the financial system. Capital positions of banks were strong in September 2022. The gross non-performing assets (GNPA) ratio has been gradually trending downwards from 9.3% in September 2019 to a seven-year low at 5.0% in September 2022, while net non-performing assets have dropped to a 10-year low of 1.3% of total assets. Macro stress tests show that banks are well-capitalized and capable of absorbing macroeconomic shocks even under adverse stress situations.

 

How does RBI assess financial stability?

The RBI stress tests assess banks’ resilience to exceptional but plausible stress events. Macro stress tests cover interest rate risk, credit risk and liquidity risk, and estimate the resilience of commercial banks in response to these shocks. RBI assesses capital ratios over a one-year horizon under a baseline scenario and two adverse scenarios i.e. medium and severe. It assists in the decision-making process, especially in terms of potential actions like risk mitigation techniques, contingency plans, and capital and liquidity management, and helps top bank managements foresee the bank’s condition in stressed times.

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Graphic: Mint

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What has been the trend of non-performing assets?

The ratio of gross NPAs to gross advances fell from 5.9% in March 2022 to 5.7% in June 2022 to 5.0% in September 2022, as against 9.3% in September 2019, facilitating broad-based expansion in bank credit. Lower fresh accretions to NPAs have been a major contributor to this. Stress tests show that GNPAs may fall further to 4.9% by September 2023.

What policy measures have helped in this?

The game-changer was the Insolvency and Bankruptcy Code introduced in 2016, which altered borrowers’ behaviour drastically. Even before IBC became effective, borrowers began lining up before lenders to repay dues. Moreover, the central bank has been maintaining the reserve ratios at 4.5% CRR and 18% SLR for quite a long time, despite making credit costly in terms of continuous hikes in policy rates. Of course, the post-pandemic economic revival is in no way less responsible for credit disbursal going up.

How can FSR be made more meaningful?

The current practice of RBI assessing the situation and NPA trends does not go to the root of the problem. The RBI could start by separating wilful defaults from the ones due to an investor-unfriendly environment, the latter being almost half of the NPAs. While the first category needs to be dealt with stringent laws, the latter demands reforms in archaic business laws such as labour reforms, especially in the absence of an exit policy.

Jagadish Shettigar and Pooja Misra, faculty members at BIMTECH.

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