By Ramesh Kanitkar
There is no standard or unique definition of financial stability. One broad definition runs along the following lines; an environment which ensures uninterrupted financial transactions, maintenance of a level of confidence in the financial system amongst all participants and stakeholders and absence of excessive volatility that unduly and adversely affects real economic activity. Financial stability is thus essential for realizing sustained growth.
In the wake of several financial crises that occurred worldwide and the devastating implications of the crises to respective economies, financial stability is now recognised as a critical function of Central Banks.
The approach adopted by Reserve Bank of India (RBI) to maintain financial stability is multi- pronged; maintenance of overall macroeconomic balance through monetary policy; improvement in the macro- prudential functioning of institutions and markets; and strengthening of micro- prudential institutional soundness through regulation and supervision. RBI implemented in the 1990s financial sector reforms in a prudent and phased manner so as to ensure a smooth transition of the financial system to the best international standards and practices.
The record of RBI in term of weathering international crises is commendable: for example the East Asian crisis in 1997 or the global financial crisis of 2008.
RBI’s financial stability Report, released in June 2011, is a scholarly document which provides a wealth of information on not only India’s financial system but also global financial system: Governor Dr. Subbarao assures us in his Foreword. The Indian financial sector has remained stable. Banks are well capitalized: the Reserve Bank continues to be vigilant and has taken certain prudential as well as macro prudential measures in order to enhance the soundness of the banking system while the focus of regulating the non- banking space continues to be on leverage and systemic inter connectedness a comprehensive review is under way to revisit certain broad principles that underpin the regulatory architecture keeping in view the economic role and heterogeneity of this sector and the recent international experience. Institutionally, the Financial Stability Development Council (FSDC) and its Sub- Committee for monitoring financial stability on an ongoing basis have been operationalised.
In contrast, the global scenario is far from encouraging. The sovereign debt crisis in countries like Greece, Pourtugal and Ireland is posing serious challenges for the stability in the entire Euro area. The higher levels of government debt in other advanced countries are adding to the uncertainty around the fiscal consolidation and its impact on international financial markets.
Emerging Market Economics (EMEs) have more comfortable fiscal space and better growth prospects. The international prices of food, energy and commodities are expected to remain high during 2011- 12. Inflation at the global level is a concern as persistence of high global commodity prices would result in lower growth and higher inflation dispersed all over.
Reverting to the Indian scenario, the Report not only highlights the strength of the Indian system but also its weaknesses.
For commercial banks, the concerns are: increased reliance on market borrowings to fund assets, increasing imbalances in the maturity profile of assets and liabilities and potential addition to asset impairment which could follow the rebound in credit off take.
Credit growth rebounded in 2010- 11 with 22.6 per cent growth in outstanding credit after a subdued performance in the previous year. To assess the impact of credit growth on banks asset quality, an empirical study was conducted to analyse the related trends in the periods identifiable with pre- global financial crisis, its aftermath and the post crisis phase. The study revealed that strong credit growth was synonymous with lowering of the risk perceptions leading to perceptible improvement in asset quality, whereas slowdown in credit growth was followed by increase in impaired assets.
The Report therefore advocates increased caution in credit selection and stringent monitoring standards to ensure that the credit growth remained immune to potential impairments should a slow down were to take place.
Exposure to priority sectors increased but high level of NPAs ( Non- Performing assets) was a cause of concern- Priority sector credit grew by 21 per cent in 2010- 11 as against which its impaired assets increased by 28 per cent. The asset quality of exposures to the priority sector especially agriculture, continued to compare unfavourably with the overall NPA ratio of the banking sector. Consequently, the gross NPA ratio for the priority sector deteriorated from 3.3 per cent to 3.5 in 2010- 11.
Regional Rural Banks (RRBs) have a large branch network in the rural areas of 11,861, accounting for 37 per cent of total rural branch network. RRBs are categorized into three categories sustainable viable with 55 RRBs, current viable with 24 RRBs, and loss making with 3 RRBs. An analysis of the performance of the 3 loss making and 24 other RRBs in the current viable category revealed some concerns. In order to align RRBs with the operational efficiency gained by other banks through IT enabled products, a Road Map for adoption of Core Banking Solution (CBs) in RRBs has been finalised.
In the co operative credit system financial soundness remained an area of concern. While the NPA ratios improved for the short- term co operative credit institutions like State Cooperative Banks and District Central Cooperative Banks, for the long- term institutions like State Co operative Agricultural and Rural Development Bank (SCARDB) the ratios deteriorated further. Though the norms in respect of minimum capital adequacy ratios have not been prescribed for the rural cooperative credit institutions, its disclosure has been put in place since March 2008.
In the field of Urban Cooperative Banks (UCBs) consolidation exercise continued. This has resulted in the reduction in the number of weak and unlicensed banks in the sector. Consequently, financial soundness has improved.
The Non- banking Financial Companies (NBFCs) sector posses certain important problems because of its heterogeneity and its systemic interconnectedness. There are Deposit Taking NBFCs and Non- Deposit taking NBFCs. The regulation of this sector has been progressively tightened. The capital to Risk- weighted Assets Ratio (CRAR) of both the categories has been raised to 15 per cent from the earlier stipulation of 12 per cent. Provisioning for standard and assets and a prudential cap on banks exposures to debt oriented mutual funds have also been stipulated.
A Working Group on NBFCS is examining issues related to regulatory gaps and identifying arbitrage opportunities that exist in the system, enhancing disclosure requirements and improved supervisory practices.
Some reforms have been introduced in the Micro- finance institutions (MFIs), following Malegam Committee recommendations: for instance, the conditionalities for considering as priority sector loans have been tightened.