Stressed banking sector, leveraged firms might drag down growth: RBI

Stressed banking sector and leveraged corporate balance sheets might block the country's economic growth, says the Reserve Bank of India (RBI).

Its biannual Financial Stability Report (FSR), issued on Friday, says investment demand remains weak.

The six-monthly report reviews macro economic conditions and the financial sector. This one says the domestic outlook remains positive, with macro economic stability. Liquidity conditions remain easy. The current account deficit remains contained. And, expectations of accelerated reforms and political stability reinforce the economic outlook. There is also optimism on global economic prospects, after years of sluggish growth.

Yet, the FSR said, dilemmas seem to continue on normalisation of monetary policy in advanced economies. This might have lent comfort to the financial markets, as seen from the record stock prices and benign treasury yields in the US. However, geopolitical risks remain elevated, with implications for financial markets and the broader economy.

At home, it says, a slump in credit disbursed by public sector banks was partly offset by finance companies, mutual funds and the capital market. However, these cannot fully substitute for banks. Hence, steps to restore the health of the banks assume urgency.

On asset quality at commercial banks, the FSR said stress testing indicated that under a baseline scenario, their average gross non-performing assets ratio might risen from 9.6 per cent in end-March 2017 to 10.2 per cent by end-March 2018. If macro economic conditions deteriorate, this ratio could increase further.

Stress on the books would also impact banks' capital adequacy ratio (CAR). Under the baseline macro scenario, two banks might fail to meet minimum regulatory level of nine per cent by March 2018. Things could be grave if macro conditions deteriorate, since six banks might record a CAR below nine per cent under this scenarios, it stated. Under such a severe stress scenario, the system-level CAR might decline from 13.3 per cent in March 2017 to 11.2 per cent by March 2018.

In this context, it said, RBI and the government were pro-actively taking steps to resolve NPA challenges; the former had activated Prompt Corrective Action to stem the slide. However, nothing can replace credit discipline and appreciation of the sanctity of commercial contracts, to ensure a robust financial system.

Come April 2018 and commercial banks in India, excluding regional rural banks, will begin to write their financial statements according to new accounting standards. This might push the bill for provisioning on expected losses from stressed loans.