The Financial Stability Report, December 2022 released by the Reserve Bank of India presents a very detailed account of the kind of challenges the Indian economy is faced with on account of the current global scenario of continued war in Europe and retaliatory sanctions and the resurgence of the Covid 19 pandemic syndrome with new mutations in some of the major developed and emerging economies of the world and the rising risks of recession in the global economy. It also talks about the degree of preparedness of the Indian financial system to deal with the stress that it is currently faced with.
The Financial Stability Report (FSR) is a semi-annual publication. The publication presents the overall evaluation of the Sub Committee of the Financial Stability and Development Council (FSDC) of the risks posed to the stability of the Indian financial system based on the inputs received from all the financial regulators.
Macro-financial Risks
In the Financial Stability Report, June 2022, concerns were raised about the rising risks of stagflation in the global economy due to multiple shocks which have not only continued to impact the economic environment in the succeeding period covered by the Financial Stability Report, December 2022 but the intensity and the degree of uncertainty caused by them, have only increased. The interplay of these multiple shocks resulted into tightening of financial conditions by the central banks on one hand and heightened volatility in financial markets, on the other hand.
In particular, the emerging market economies (EMEs) such as India, were posed to greater risks on account of debt fragility, currency volatility and capital outflows in an intricately connected global financial system as many central banks across countries aggressively front-loaded monetary policy tightening and have given hawkish outlook for the coming periods. No wonder, almost all international organizations, including the International Monetary Fund (IMF), the World Bank (WB) and the Organization for Economic Co-operation and Development (OECD) have downgraded their global growth projections relative to their previous revisions as shown in the Chart below:
The Global trade volume is also projected to decrease from 10.1 per cent in 2021 to 4.3 per cent in 2022, and the emerging economies have been badly hurt by this slowdown. Moreover, Inflation is forecast to rise to 8.8 per cent in 2022, with both headline and core inflation staying well above targets in both in the advanced and emerging economies. The outlook for the year 2023 is no better projected either.
In contrast, the Indian economy has been consolidating a recovery and showed a great degree of resilience despite having been affected by waves of the pandemic due to strong revival of agriculture and services, stable corporate performance despite rising input costs, enhanced business and consumer optimism, and above all the support extended by a sound financial system. Indian economy has shown remarkable capacity to effectively tackle extraordinary external shocks emanating from prolonged geo-political hostilities and the resultant complexities on the back of increase in personal consumption and gross fixed capital formation, which even offset the negative contribution of net exports.
Macro financial Development and Outlook
Global financial conditions have tightened substantially due to monetary policy actions by central banks aiming at balancing the twin objectives of maintaining both price and financial stability and also on account of the elevated levels of uncertainty. The tightening of financial conditions has resulted in negative returns for almost all asset classes. the upsurge in market volatility and sporadic sell-offs in asset markets have heightened macro-financial risks globally.
The RBI has observed that Indian economy remains vulnerable to formidable global headwinds, which act as a drag on the domestic economic recovery. Particularly despite the headline consumer price index (CPI) inflation having been moderated in the recent times there are still pressures that might push core inflation up. The focus of the monetary policy will then continue to take proactive actions to contain inflation within the tolerance band and as close as possible to the target rate.
Domestic Economy and Markets
The Indian economy has to reckon with strong global headwinds. Several front-loaded measures and supply side interventions adopted by the RBI to control Inflation have caused a retreating movement in inflation indices even as it continued at elevated levels. The improvement in the asset quality, profitability and resilient capital and liquidity buffers in the financial sector have given a boost to the buoyant demand for bank credit and supported a revival in investment cycle. These strengths have helped the financial system to effectively deal with the impact of external spillovers, tightening global financial conditions and high volatility in financial markets.
Financial Institutions: Soundness and Resilience
Capital positions of scheduled commercial banks (SCBs) is reported to have remained strong in September 2022. The Capital to Risk Weighted Assets Ratio (CRAR) and Common Equity Tier 1 (CET1) ratio of SCBs stood at 16.0 per cent and 13.0 per cent, respectively. The gross non-performing assets (GNPA) ratio of the SCBs has recorded a seven-year low of 5.0 per cent in September 2022, while net non-performing assets (NNPA) have come down to ten-year low of 1.3 per cent of total assets. The provisioning coverage ratio (PCR) has been increasing steadily since March 2021 to 71.5 per cent. The profit after tax of SCBs registered a growth of 40.7 per cent in the first half of the financial year 2022-23, largely due to strong growth in the net interest income and a reduction in provisions.
Moreover, the SCBs stood well-capitalized and all banks would be able to comply with the minimum capital requirements even under adverse stress scenarios, observes the FSR report.
Positive signs were seen in the other constituents of the financial system also. The CRAR of urban co-operative banks (UCBs) had increased to 16.1 per cent in September 2022 while that of non banking financial companies (NBFCs) stood at 27.4 per cent. The consolidated solvency ratio of the insurance sector remains above the minimum threshold limit of 150 per cent.
According to the findings of the network analysis, the total outstanding bilateral exposures among constituents of the financial system are indicated as stable. SCBs continued to have the largest bilateral exposures in the Indian financial system, which reached pre-pandemic levels in September 2022. According to the FSR, the simulated contagion analysis shows that losses due to failure of five banks with the maximum capacity to cause contagion would not lead to failure of any additional bank.
Regulatory Initiatives and Other Developments in the Financial Sector
Globally, the focus of prudential regulation remains on how to protect the financial system from spillover effects of synchronized monetary tightening by central banks in light of highly uncertain economic environment. Besides, they also aim at enhancing the resilience of non- bank financial intermediaries (NBFIs) and assessing climate-related financial risks. On the domestic front, the emphasis of regulatory supervision continues to be on improving the resilience of the financial system and fostering a conducive credit environment that supports a sustainable economic recovery and preserves financial stability.
Assessment of Systemic Risk
The Reserve Bank’s latest Systemic Risk Survey (SRS) has reported that there is an increase in the effect of global spillovers, financial market and general risks. The monetary tightening measures taken up in advanced economies, tightening of financial conditions, geopolitical risks, uncertainty about global growth prospects and growing risks from private cryptocurrencies and climate change are considered as the major contributors to the increase in the global, financial market and general risks. But, at the same time, the macroeconomic risks have moderated and institutional risks have reported to have remained the same. As per the FSR, majority of the respondents observed that there may be further improvement in credit prospects for the Indian economy and posed confidence that the prospects of Indian banking sector are likely to improve or remain unchanged over a one-year horizon.
Reference: This article is published by the Author in the Newsletter “KnowFunda Digest” (3rd Edition) on LinkedIn on January 1, 2023.