Financial Institutions – Soundness And Resilience


(From RBI lens)

Indian banks bolstered risk absorbing capacity and should withstand severe stress

The financial turmoil due to covid-19 posed a risk to the financial stability of banks. The government and the RBI unveiled large doses of policy and regulatory support to the banks and financial institutions to traverse the waves of the pandemic. While there are grounds for optimism as the regulatory and budgetary support has been constructive and progressive, some obstacles remain.

The RBI’s financial stability report released on June 30, 2022, highlighted the significant strengthening of the banking ecosystem which bolstered its risk absorbing capacity as gross non-performing assets declined to their lowest levels in six years. The RBI noted that the macro stress tests reveal that all banks would be able to comply with minimum capital adequacy norms even in a severe stress scenario, although some segments as well as non-banking financial companies may be vulnerable to liquidity shocks.

Nevertheless, the improvement in the banking system is remarkable. Banks’ gross non-performing assets declined to a low of 5.9% in March 2022 from 7.4% in March 2021, the RBI stated, while net NPAs fell by 70 basis points to 1.7% as on March 2022. The improvement highlights banks have been able to significantly strengthen their risk absorption capacity.

Post the lockdowns, the resulting improvement in economic activity aided banks to resume lending that is at the heart of economic growth. “With the progressive
normalisation of economic activity, banks were able to kick start a fresh lending cycle while simultaneously improving profitability,” pointed out the RBI. This shows the steady improvement and progress of the banking ecosystem.

Credit cycle expansion

The importance of the uptick in the credit cycle shows the resilience of the Indian economy. Bank credit picked up in the second half of FY22, rising to 11.5% in March 22, and again to 12.9% on June 3, 2022. Both the public and private sector banks have shown increased lending. Credit to the industry improved significantly.

One thing to note is that public sector banks recorded growth in industrial credit after almost three years of contraction, which highlights that businesses have been recovering well after the lockdowns. RBI has also pointed out that new loans have increased too. “Rapid credit expansion during the second half of FY22 was aided by new loan accounts in the industrial and services sector with the share of new loans in total loans increasing in successive quarters of the year,” the RBI stated.

Besides, personal loans remained steady accounting for over 30% of incremental lending by banks. Housing loans, credit card receivables and auto loans all recorded double digit growth.

Asset quality improves

While banks have enhanced their asset quality in both gross and net non-performing assets, provisioning coverage also showed great improvement. Credit quality has also improved across major sectors, but it remained elevated in sectors such as gems and jewellery and parts of the construction sector. The asset quality of the personal loan segment too improved.

Large borrowers, with aggregate fund-based and non-fund-based exposure of Rs 5 crore and above, have seen a decline in loans in recent years. This indicates a reduction in credit concentration and better diversification of borrowers.

“The provisioning coverage ratio improved to 70.9 per cent in March 2022 from 67.6 per cent a year ago. The slippage ratio, measuring new accretions to NPAs as a share of standard advances at the beginning of the period, declined across bank groups during 2021-22,” stated the RBI. This indicates that banks have focussed on improving lending practices thus conferring increased focus on strengthening balance sheets.

Enhanced profitability

Another good sign is the improvement in capital-to-risk weighted ratio (CRAR) due to earnings retention supported by capital augmentation. CRAR has been rising since March 2020, improving to 16.7% in March 2022. “The system level Tier-I7 leverage ratio has also been rising after March 2020 and stood at 7.1% in March 2022,” pointed out the RBI.

Banks’ net interest margins increased marginally during 2021-22 and stood at 3.4%. NIMs of all bank groups in the first half of FY22, however, public sector banks posted lower margins compared to private banks. Growth in profit after tax has been significant. Even the return on assets and return on equity improved in the second half.

Cost of funds also moderated. “After declining continuously for the last two
years in tune with easy monetary and liquidity conditions, the cost of funds and yield on assets for SCBs settled at 4.1% and 7.1%, respectively, which were 10 bps lower than their levels in the previous half-year,” noted the RBI.

Stronger banking ecosystem

Banks have also been able to improve profitability in a way that can effectively address cyclical systemic risks. Coming on the heels of the covid-19 pandemic, the strength suggests an effective banking ecosystem that should be able to withstand further economic shocks.

The stress test after the pandemic with the covid-19 effects becoming clearer, shows absolute levels of improvement even without further capital infusions. “Stress test results reveal that SCBs are well-capitalised and capable of absorbing macroeconomic shocks even in the absence of any further capital infusion by stakeholders,” notes the RBI.

A very important consideration of the test reveals that even under severe stress, the CRAR of 46 major banks could slip from 16.5% in March 2022 to 13.3% in March 2023.

The prospect of a serious drag on the economy because of the stressed banking system has decreased considerably. The RBI and the government has shifted the gears of the banking system significantly elevating the potential impact of covid-19.

The RBI’s Financial Stability Report indicates that banks will be able to buffer future impact. From the banks’ perspective, the more important point is that they will be able to proceed with good caution even in the current circumstances of elevated interest rates, higher oil and food prices, and the global impact of the Ukraine crisis. The stress test gives much better information about the system. It also shows the results of the post-pandemic work by the RBI is remarkable in upping the resilience of banks.

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