Introduction
The Financial Stability Report (FSR) for India is being
published biannually in June and December for the last
three years. The FSR includes the contributions from all
the financial sector regulators and is currently being
approved by the Sub–Committee of the Financial
Stability and Development Council (FSDC).
Structure of FSR
The first chapter of the FSR discusses macro-financial
risks in the global and domestic economies and markets,
providing a backdrop in which the financial system has
been functioning. The second chapter of the report
focusses on the soundness and resilience of financial
institutions and discusses, amongst other things, the
interconnectedness of the financial system. It presents
the results of various stress tests conducted for
assessment of resilience of scheduled commercial banks,
scheduled urban cooperative banks and non-banking
finance companies, to different types of risks. The
chapter also includes coverage on insurance and pension
sectors, which are important segments of the financial
services sector. The last chapter gives an assessment in
the progress of implementation of post crisis reforms
proposed by G20/ Financial Stability Board, with specific
reference to Indian position, and also includes other
regulatory issues of systemic importance. The findings
of the Systemic Risk Survey are presented at Annex 1.
Methodology underlying some of the analytics used in
the report is given at Annex 2.
Macro financial Risks
Global Economy and Markets
The announcement by Federal Reserve of the phased
withdrawal from the bond buying programme has
signalled the inevitability of eventual exit from the
unconventional monetary policies adopted by major
central banks. The risks which have been building up over the last five years of excess liquidity in the global
system are now surfacing. The markets, especially in
emerging economies need to be prepared for spells of
high volatility and uncertainty going ahead. Global
growth remains tepid and multipaced. Asset bubbles in
housing might have been building up in certain parts of
the globe.
Domestic Economy and Markets
The macroeconomic risks to Indian economy have
increased over the last six months, mainly on the
dimensions of domestic growth, external sector and
corporate sector performance. Domestic supply
bottlenecks, policy uncertainty, consequential dampened
investment sentiment and slackening external demand
contributed significantly to the slowdown, though fall
in inflation and significant fiscal correction have
provided some relief.
Current account deficit and its non- disruptive financing
have emerged as major challenges from the perspective
of macroeconomic stability. Various measures taken to
dampen import demand for gold are taking hold and
policy efforts are currently on to attract more stable long
term capital through foreign direct investment (FDI)
route.
The performance of Indian corporate sector has been
subdued and in the emerging scenario, their increased
external borrowing and unhedged foreign exchange
exposures may further increase their vulnerabilities. On
the fiscal front, there has been some credible
improvement, reflecting in upgrade of outlook on India
to ‘stable’ by one of the major credit rating agencies.
Financial Institutions: Soundness and Resilience
Scheduled Commercial Banks
Risks to banking sector have increased since the
publication of the last FSR in December 2012, mainly in
terms of asset quality and profitability. The asset quality continues to remain under intense focus and prudential
measures have been taken to step up the provisions on
restructured accounts. The FSR also analyses the
improved performance on parameters of credit and
deposit growth, asset quality etc during the last quarter
of the financial year and finds significant ‘seasonality’
in these parameters. The contraction in export credit
during recent quarters is attracting the attention of
policy makers. The growth in credit to micro and small
enterprises (MSE) sector needs to be sustained.
Interconnectedness in the financial and banking
systems
The Banking Stability Measures, based on co-movements
in equity prices of listed banks, have shown some
improvement in distress dependencies between banks.
The network of the Indian financial system shows that
the asset management companies and insurance
companies have a high degree of exposure to the banking
system. The liquidity contagion analysis brings out the
risks from interconnectedness entrenched in the
structure of the financial system.
Stress Tests
Macro stress tests indicate that if the current
macroeconomic conditions persist, the credit quality of
commercial banks could deteriorate further. However,
the comfortable position on the banks’ capital adequacy
front lends resilience as shown by the top-down stress
testing exercises on various risks. The results of the
bottom-up stress tests (sensitivity analysis) carried out
by select banks, also testify to the general resilience of
the banks to different kinds of shocks. This issue of FSR
introduces the analysis of NPAs on the basis of Estimated
Losses approach for assessment of provisioning and
capital adequacy of banks. The results show that, while
the present level of provisions is adequate, a gap may
arise under severe stress scenario.
The stress tests on capital and liquidity aspects of the
scheduled urban cooperative banks (SUCBs) reveal that
the SUCBs may be impacted, under severe stress
scenario. The stress tests on credit risks for NBFCs show that even under the severe stress scenario related to
deterioration in asset quality, the capital adequacy ratios
remain above the minimum required level.
Insurance and Pension Sectors
The new business premium of insurance sector
continued to contract for the last two years. Single
premium insurance policies account for a major part of
the life insurance business, especially of the Life
Insurance Corporation. New Pension System introduced
by the Government of India with a view to develop the
pension sector has shown significant growth in the
subscriber base and corpus.
Financial Sector Regulation and Infrastructure
Implementation of reforms at global level
The uneven progress on implementation of agreed global
reforms in various jurisdictions is accompanied by a
concurrent rethinking on the architecture and desirable
degree of financial regulation. While the needs of
different financial systems are expected to be different
in terms of regulatory emphasis, the trends towards
home-bias in regulation may have consequences for
functioning of international markets, with varied effects
on different jurisdictions.
India’s progress on reforms
India’s progress on implementation of various globally
agreed reforms is being monitored under the framework
of FSDC, through its Sub Committee. Inter-agency
implementation groups have been formed, with focus
on specific areas of reforms.
Basel III
India’s implementation plan for Basel III reforms is more
stringent in terms of schedule as well as capital
requirements, in keeping with the traditionally prudent
approach and to make up for judgemental errors, if any,
in computing the capital requirements. Indian banks are
facing challenges in implementation of AMA approaches
for computing capital charge for operational risks on
issues related to internal governance, data availability and modelling of operational loss data etc.
OTC Derivatives
The implementation of reforms in OTC derivative
markets in India is being taken up in a phased manner,
with standardisation of products and introduction of
centralised clearing in more segments of OTC market.
The US and European laws dealing with OTC derivatives
reform have raised concerns over possibilities of extra
territorial regulatory jurisdiction which may lead to
regulatory clashes and disruptions in market activity.
Supervision of Financial Conglomerates
Significant steps towards strengthening of the
supervision of big financial groups have been taken in
India, in recent period. The financial sector regulators
have formalised a mechanism for co-operation in
supervision for financial conglomerates and an Inter
Regulatory Forum (IRF) has been set up, under the FSDC
Sub Committee. Bilateral Memoranda of Understanding
(MoU) have also been been signed with overseas
supervisory bodies for improved cross border banking
supervision and cooperation. Supervisory Colleges have
been established for two big Indian banks.
Regulation of Shadow Banking
Significant regulatory measures have been taken to
address the possibilities of liquidity risks emanating
from money market and liquid mutual funds. The
observed circularity in flow of funds between banks and
mutual funds could lead to systemic risk in times of
liquidity stress. The regulatory gaps observed in case of
‘collective investment schemes’ and some other
methods through which various entities try to raise
funds from public are being addressed through a coordinated approach, while seeking a more active role
for the state governments and law enforcement agencies.
Consumer Protection
Instances of mis-selling of insurance policies, wealth
management products and services and some other
unhealthy practices at some banks have underscored
the need for strengthening the consumer protection
mechanism, adherence to KYC / AML guidelines and
removal of certain distortions observed in the incentive
framework.
The technology risks in times of increasing use of
internet for various purposes, pose fresh challenges.
The risks from obsolescence of existing technology
platforms and outsourcing of business processes by
banks need greater attention.
Financial Market Infrastructure
The financial market infrastructure, including the
payment and settlement systems in the country has
been functioning smoothly. There is a need for
addressing the possible concentration risks from the
exposure of the main two equity market clearing houses,
to a common set of banks.
Systemic Risk Survey
According to the results of Reserve Bank’s latest Systemic
Risk Survey, conducted during April – May 2013, global
risks and domestic macro-economic risks were perceived
to be the two most important factors affecting the
stability of Indian financial system. However, participants
in the survey have expressed confidence in the stability
of the Indian financial system. |