International Monetary Fund (IMF) On Wednesday said that the Indian banking entities, which grew the asset books rapidly, have become more vulnerable to adverse effects of global financial meltdown and liquidity squeeze.
The rising credit risks and liquidity pressures could put the financial system under strain, the multilateral agency said in its report released after its executive directors concluded consultation with India.
At the same time, IMF said that Indian banks were well capitalised and relatively liquid. Despite worries from various agencies about the level of non-performing assets (NPAs) doubling to around 4.5 per cent of their advances by 2010, IMF said that the level of bad debt was low.
At the end of March 2008, gross NPAs accounted for 1.3 per cent of the total assets of the banking sector. Net NPAs, after banks made the required provisions, were estimated at 0.57 per cent.
It flagged the concerns emerging from the volatile global financial markets. The rapid growth in the last few years especially through domestic credit book and foreign liabilities has increased banks’ vulnerability to global deleveraging and slowing economic activity.
Consequently, their share prices have fallen sharply and their credit default swap (CDS) spreads and default probabilities have risen, IMF added.
The credit growth remains relatively high, though this in part reflects the switch of corporate funding to banks as financing from other sources has declined, it added.
Credit growth has moderated from nearly 30 per cent on a year-on-year basis at the end of October to a little over 18 per cent now due to a fall in demand for loans and also due to the risk aversion by banks.
IMF said directors commended the strength and resilience of India’s financial system which is reflected in favorable financial soundness indicators.
However, they stressed that rising credit risk and liquidity pressures could put the financial system under strain. The negative feedback loops between the real and financial sectors could turn out to be strong. The authorities should take additional steps to prevent adverse fallout of risks, the report said. It suggested some steps like zeroing on potential banks that need re-capitalisation.
The Union government has already drawn up plan to infuse Rs 20,000 crore in public sector banks to maintain capital adequacy of 12 per cent, a capital buffer deemed comfortable to face adverse situation.
IMF directors favoured full disclosure of bad assets (NPAs) and closing of the information gaps. The reforms should be persevered to deepen and further strengthen the financial sector, develop the corporate bond market, and improve banking efficiency.
Directors pointed out that though corporate balance sheets have been strong, slowing economic growth and tighter financing conditions could increase corporate distress.
They encouraged the implementation of reforms to strengthen corporate governance and the regulatory framework for corporate restructuring.
