RBI Financial Stability Report (FSR): Key Takeaways

The RB I released its Financial Stability Report (FSR) covering the key aspects of the financial stability of the financial markets in general and banking system in particular. Here are the key takeaways from the FSR report and what it means for banks in general…

• The RBI sees distinct risks to the global financial system at a macro level. These risks principally stem from a slower growth in productivity and a greater trend towards protectionism. Countries and economies are increasingly becoming inward looking as is evident from the noises emanating from the US with respect to China and also with respect to noises emanating from Britain pertaining to the cost of being in the EU.

• The RBI FSR believes that the monetary policy across the world has been largely accommodative over the last 8 years since Lehman. Despite the hawkish tone of the US Fed, the RBI does not see this global stance changing too drastically.

• The RBI also sees the beginning of the shift out from total focus on monetary policy towards an eclectic approach with an accent on fiscal policy too. The US has taken the lead. Trump announced reduction in tax rates as well as greater expenditure on infrastructure building. With interest rates at historic lows, most central banks are seeing the futility of entirely depending on a monetary approach. The shift towards greater accent on fiscal measures may gather momentum.

• On the domestic front, the RBI has expressed the worry that the demonetization could create distinct risks for output, growth and wages in India. The actual data is yet to come out but the RBI does see risks to growth stemming from the liquidity crunch created. This may partially temper the benefits of proactive legislations like the GST Bill and the Bankruptcy Code.

• RBI sees distinct risks on the external capital flows front. While the Current Account Deficit (CAD) was well under control at 0.6%, it has shown a tendency to overshoot if oil prices go further up. Further, remittances have slowed even as capital flows from FPIs have become volatile after the hawkish tone adopted by the US Fed.

• The RBI’s real worry is on the strength of the Indian banking system. The banking stability index has shown distinct signs of weakening during the year due to a combination of weak asset quality, constraints on liquidity and pressure on profitability.

• The Gross Non Performance Assets (GNPA) has moved up sharply from 7.8% in March 2016 to 9.1% in September 2016. This has pushed up the overall stressed advances up from 11.5% to 12.3% during the same period.

• The problem of GNPAs continues to be really acute in case of the public sector banks (PSBs) as compared to the private banks. In fact, the GNPA level of PSBs is likely to worsen to over 13% by March 2017, raising serious concerns over the sustainability of regular operations of these banks. The overhang of NPAs continues despite the best efforts of the RBI to force banks to write off as much of NPAs as possible in the last few quarters.

• The stressed sectors are the normal suspects. Steel, power and infrastructure are among the major sectors that have caused NPAs in the banking system. With the outlook for each of these sectors looking highly volatile in the medium term, there is unlikely to be any worthwhile recovery in the financials of these sectors. More so, considering that China is already sitting on substantial excess capacity in most of these sectors. That itself will put a cap on prices and therefore profitability in these sectors.

• Lastly, in terms of systemic risks, the RBI foresees a medium level of risk emanating from the global macros. US Fed stance, BREXIT and China’s growth could be key global macros to watch considering their far reaching potential impact. However, the RBI does not see any major disruptive shift caused by any of these events in the next one year.

The focus of the RBI FSR is largely on the problems in the Indian banks system. The fortunes of the PSB banks, at least, are tied to a revival of key industries like metals, power, telecom and infrastructure. That is not too evident in the IIP and PMI numbers and demonetization may have created its own share of problems for the Indian growth story. That remains the abiding theme of the RBI FSR.