The Reserve Bank of India (RBI) has asked the banks to beef up its resource mobilisation efforts as the country readies to take a higher growth path following the reforms measures of the central government.
The comment comes amid slowing growth of deposit and depleting capital position of banks in addition to a nine-year low rate of domestic household savings in 2012-13, which has shown only a marginal pick up in the current financial year.
“Pickup in credit assumes importance in the present context given that credit cycles have been leading business cycles in the post reform period,” the central bank said in its Financial Stability Report released today.
“Banks, therefore, need to prepare themselves to meet credit demand as investment picks up,” it added.
Credit growth, on year on year basis, fell to 10.9% till December 12, which is lowest since 2007. Deposit growth has also fallen to 10.6%. The gross domestic saving rate declined to 30.1% in 2012-13, the lowest in the past nine years.
Household savings rate, however, shown marginal improvement in 2013-14, largely with respect to bank deposits and small savings.
“Revival in investment activity needs to be supported by an increase in financial savings,” RBI said.
On economic indicators, the RBI said it expects consumer price inflation to hover around 6% in the next 12 months if global crude prices remained steady and monsoons normal. The RBI has a target of bringing consumer inflation down to 6% by March 2015. The central bank also expects India’s economy to grow 5.5% in the fiscal year ending March and then slowly pick up momentum in the following year.
Noting that growth in the banking system further moderated along with decline in profitability, the report said lacklustre demand for credit is mainly due to corporate sector availing alternative sources of fund and risk aversion.
The biggest worry for the regulator remains asset quality and the high level of stressed asset. Gross non-performing asset in the banking system rose to 4.5% of gross advances in September 2014 as compared to 4.1% in March. Total stressed asset in banks (GNPA + restructured advances) rose to 10.7% from 10% during the six month period.
“The extent of restructured assets in the banking sector, especially public sector banks, is a cause of serious concern the relatively higher possibility of slippages in restructured standard advances is required to be factored in by banks from the capital adequacy perspective,” RBI said.
According to the central bank, the level of stress has increased for 46 banks that account for 88% of the total loan portfolio, between March and September.
Five sub-sectors, namely, infrastructure, iron and steel, textiles, mining (including coal) and aviation, has significantly higher levels of stressed assets which accounts for 52% of total stressed advances of all banks as of June 2014. Banks’ exposure to infrastructure sector was 15.6% of their total loans.
RBI also said that the close ties between banks would leave the banking system vulnerable to contagion in case of trouble at a single institution. This means trouble at a single bank among the top five most connected lenders in India could lead to contagion that wipes out nearly 50% of Tier I capital in the banking system under a severe stress scenario, the RBI said.
“This underscores the importance of monitoring not just interconnectedness, but also the counterparties and magnitude of exposure involved in the connection,” the RBI said, without identifying the top five banks used for its study. It said its stress tests involved conditions such as potential failure by a bank that is either a net lender, a net borrower, or both.
The RBI also used money markets as one of its variables for stress tests given banks frequently lend to each other in short-term maturities.
On other risks in India’s financial system, the RBI highlighted the need for “closer examination” of the practice of promoters who pledge a substantial portion of company shares to get loans.
Pointing out the need for improving project appraisal by banks themselves rather than merchant bankers which has a vested interest in closing the financial closure, RBI said, “since banks, traditionally have been short term working capital providers, their appreciation of idiosyncratic risks in infrastructure projects seems to have been inadequate.”
Since RBI mandates that all standard restructured advances will attract provisioning in line with sub-standard assets from April 1, 2015, this will led to rise in provision requirement by banks which will exert pressure on profitability. At present banks enjoy the regulatory forbearance of having lower provisioning for restructured standard advances which will cease to exist from April 1, 2015 and in the report RBI has justified the move saying forbearance for extended periods and as a cover to compensate for lenders/borrowers’ inadequacies engenders moral hazard. Banks have requested RBI to extend the forbearance by one year.