There are three distressing features of the Reserve Bank of India's latest Financial Stability Report. The first is a sharp drop in growth of deposits.
At less than 14%, the deposit growth rate as on March 31, 2012, is the lowest recorded in the last 10 years. True, some such decline is inevitable during an economic slowdown, especially when high inflation leads to negative or low real rates of interest.
But the extent of the decline is a cause of concern. Not only because bank deposits are the mainstay of bank credit but also because the disproportionate slowdown in deposit growth vis-a-vis credit growth has increased the reliance of banks on borrowed funds, raising the spectre of liquidity mismatch.
The second feature relates to asset quality. The report points to a rise in the quantum of restructured assets and non-performing assets (NPAs), with gross NPAs rising to 2.9% on March 31, 2012, against 2.4% on March 31, 2011.
The third relates to the growing interconnectedness between the 'most-connected' banks. The maximum potential loss to the banking system due to the failure of the most-connected bank has risen from 12% of the capital of the banking system to over 16% over the four quarters of 2011.
The average loss caused by the failure of the three most-connected banks has also increased. Fortunately, the contagion risk appears confined to a few banks. Interconnectedness is not confined to banks but extends to insurance and the mutual funds segments of the financial system.
As on March 31, 2012, nearly 54% of the entire intra-financial system borrowing by banks was from insurance companies and mutual funds, with the reliance being particularly high in the case of private sector banks.
This means the random failure of a bank that has large borrowings from insurance and mutual funds could have significant implications for the entire system.
The good thing is that for now, tests suggest the banking system is in reasonably good shape. But that does not mean we should relax our guard. Stress tests have their limitations. After all, it is not so long ago that EU stress tests showed Spanish banks in fine fettle.
At less than 14%, the deposit growth rate as on March 31, 2012, is the lowest recorded in the last 10 years. True, some such decline is inevitable during an economic slowdown, especially when high inflation leads to negative or low real rates of interest.
But the extent of the decline is a cause of concern. Not only because bank deposits are the mainstay of bank credit but also because the disproportionate slowdown in deposit growth vis-a-vis credit growth has increased the reliance of banks on borrowed funds, raising the spectre of liquidity mismatch.
The second feature relates to asset quality. The report points to a rise in the quantum of restructured assets and non-performing assets (NPAs), with gross NPAs rising to 2.9% on March 31, 2012, against 2.4% on March 31, 2011.
The third relates to the growing interconnectedness between the 'most-connected' banks. The maximum potential loss to the banking system due to the failure of the most-connected bank has risen from 12% of the capital of the banking system to over 16% over the four quarters of 2011.
The average loss caused by the failure of the three most-connected banks has also increased. Fortunately, the contagion risk appears confined to a few banks. Interconnectedness is not confined to banks but extends to insurance and the mutual funds segments of the financial system.
As on March 31, 2012, nearly 54% of the entire intra-financial system borrowing by banks was from insurance companies and mutual funds, with the reliance being particularly high in the case of private sector banks.
This means the random failure of a bank that has large borrowings from insurance and mutual funds could have significant implications for the entire system.
The good thing is that for now, tests suggest the banking system is in reasonably good shape. But that does not mean we should relax our guard. Stress tests have their limitations. After all, it is not so long ago that EU stress tests showed Spanish banks in fine fettle.
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