The Indian financial sector can withstand shocks, says a report
The Indian financial sector can withstand shocks, says a report
Sometimes it pays to overstate the obvious. The Committee on Financial Sector Assessment (CFSA), chaired by Rakesh Mohan, deputy governor of the Reserve Bank of India (RBI), tells us what we already know: that “the Indian financial sector is generally sound, resilient and fairly liquid”. The report was the outcome of a self-assessment that the CFSA undertook, beginning in 2006. Predictably, there are concerns, many concerning how skewed the sector is on several aspects.
The devil is in the details, of course, and given the length of this report — it runs into six volumes — there are plenty of them. Take liquidity, for instance, the issue that has engaged both banks and borrowers the most in recent months.
In its report, the CFSA says that “there is a growing dependence on purchased liquidity and also an increase in the illiquid component in banks’ balance sheets with greater reliance on volatile liabilities, like bulk deposits to fund asset growth”. More simply put, the extent of asset liability mismatches in banks — the idea is that the duration of assets (loans) should match the duration of liabilities (deposits) — is creating bigger and bigger liquidity risks.
Recall what happened in September 2008? Banks had to borrow at rates in excess of 20 per cent from the call or inter-bank overnight money market to meet their needs. The CFSA is saying that growing a credit portfolio when a stable deposit base is absent is not feasible any more. It goes so far as to suggest that banks set aside capital, for liquidity risk, if purchased or borrowed liquidity crosses a certain threshold.
The report — which involved some 250 beautiful minds — is a comprehensive self-assessment of financial stability and compliance with standards that would be the basis of a medium term reform roadmap. Over the past two years, the CFSA has done a considerable amount of stress-testing — a technique to roughly measure how the value of a portfolio for an institution can change if there are large changes in some of the risk factors. It can also be applied to a subset of the financial system, say banks.
Take non-performing assets (NPAs) as an example. If NPAs go up from their levels in March 2008 by 25 to 50 per cent, only five banks would be affected. If NPAs went up by 100 per cent, eight banks could be seriously impacted. The information is useful for taking early remedial action by the regulator. It also helps estimate risks to the stability of the system as a whole, given the linkages that these banks could have with other banks.
For Indian banks, the news was good: even when the test was conducted for, the results showed the system as being capable of withstanding shocks. “The impact of credit risk on the capital position continues to be relatively muted,” says Mohan. “Even under the worst-case scenerio, capital adequacy (for the banking industry) remained well above the regulatory minimum (of 9 per cent),” adds Mohan.
But it is not all good news. The report highlights several gaps and shortcomings that could delay the implementation of such a road map. For instance, there is no way of measuring household indebtedness, important when we think of the growing amount of consumption being financed by bank credit.
The report also underscores governance issues related to cooperative banks, and the conflicts of interest the government faces in owning most of the banking system. For foreign banks, the opportunity to expand their footprint and branch network will have to wait for a while longer. The message from the CFSA’s report is also predictable: proceed with caution. In the current scenario, that may not be a bad thing.
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