The Reserve Bank of India (RBI) recently released the 23rd issue of its Financial Stability Report (FSR), a biannual publication that reflects the collective assessment of the Sub-Committee of the Financial Stability and Development Council (FSDC). Headed by the Governor of the RBI, the FSDC provides analyses on risks to financial stability and resilience within the financial system, while also discussing pertinent issues relating to the development and regulation of the financial sector.
Impact of Covid-19 Second-Wave
The second wave of Covid-19, despite its economic disruption, has had less impact on the balance sheets of Indian banks than initially projected. The report highlights that capital buffers, which are required reserves held by financial institutions as per regulatory guidelines, remain resilient enough to withstand future shocks. These buffers serve to aid banking organisations in supporting the economy during adverse situations.
The monetary, regulatory, and fiscal policy measures taken in response to the second wave have effectively curtailed the solvency risk of financial entities, stabilized markets, and maintained overall financial stability. Solvency risk is defined as the inability to absorb losses with available capital.
Global Recovery and New Risks
The global recovery from the pandemic continues at an uneven pace, bolstered by sustained policy support, benign financial conditions, and increasing vaccinations. This support has strengthened the financial positions of banks, containing non-performing loans and ensuring continued solvency and liquidity worldwide.
However, new risks have surfaced including the still developing state of economic recovery, vulnerability to future pandemic waves, international commodity price fluctuations, inflationary pressures, potential global spillovers and an escalating number of data breaches and cyber attacks.
Gross Non-Performing Asset Ratio
The Gross Non-Performing Asset (GNPA) ratio of India’s Scheduled Commercial Banks (SCBs) could reach 11.2% by the end of 2021-22, an increase from 7.48% in March 2021, under a severe stress scenario. Under a baseline scenario, this ratio may increase to 9.8% by March 2022.
There are signs of stress within the Micro, Small and Medium Enterprises (MSMEs) sector and retail segments. The demand for consumer credit across banks and Non-Banking Financial Companies (NBFCs) has decreased, as the risk profile of retail borrowers deteriorates.
CRAR & PCR
Banks successfully managed to capitalise themselves during 2020-21, ensuring sufficient capital adequacy even under stressful conditions. As of March 2021, the Capital to Risk-Weighted Assets Ratio (CRAR) of SCBs reached 16.03%, while the Provisioning Coverage Ratio (PCR) stood at 68.86%.
Restructuring of Loans
In response to the pandemic, the RBI introduced a one-time loan restructuring scheme during 2020-21 to aid affected borrowers. By March 2021, 0.9% of total bank advances were under restructuring, with MSMEs accounting for the highest restructure ratio at 1.7%.
Suggestions for Future Stability
To fortify themselves against potential balance sheet stress, banks need to reinforce their capital and keep sufficient liquidity positions. Sustained policy support, coupled with the fortification of capital and liquidity buffers by financial entities, is imperative. Stronger capital positions, good governance and efficiency in financial intermediation are vital in meeting the financing needs of productive sectors while securing the integrity and soundness of banks and financial institutions on a long-term basis.
Understanding Non-Performing Assets (NPA)
NPAs are loans or advances that are in default or are in arrears on scheduled payments of principal or interest. In most cases, debt is classified as non-performing, when the loan payments have not been made for a minimum period of 90 days. Gross NPAs are the sum of all defaulted loans, while net NPAs are the amount realised after the provision amount has been deducted from the gross NPAs.
Capital Adequacy Ratio (CAR)
The CAR, also known as Capital-to-Risk Weighted Asset Ratio (CRAR), is a bank’s capital in relation to its risk weighted assets and current liabilities. It is regulated by central banks to prevent commercial banks from taking excessive leverage and risking insolvency.
Provisioning Coverage Ratio (PCR)
The PCR refers to the prescribed percentage of funds that banks must set aside to cover prospective losses due to bad loans.
