Financial health seems fine

The Reserve Bank of India came out today with its health check report for the country’s financial sector — the third in the past 12 months — and pronounced that it was in fine fettle but admitted there were some wobbles ahead for the economy.

The report said the economy faced downside risks from a slowdown in global recovery, high oil and commodity prices, and sovereign debt problems in the Euro area and a decline in domestic investment demand.

However, it added that the Indian financial system was stable despite some fragility in the global macro-financial environment.

For the banking sector which has been witnessing a hike in key interest rates because of stubborn inflation, the report said that increasing interest rates, hike in the savings account rate, amortisation of pension and gratuity liabilities and potentially enhanced provisioning requirements for non performing assets might impact their profitability.

The report also raised some caution on the structure of bank’s loan books. Though the credit portfolio of commercial banks was diversified across industries, geography and sectors, the report said that during the last few years, incremental credit growth was observed to be mainly propelled by credit growth in a few sectors — retail, commercial real estate and infrastructure.

In March 2011, these sectors accounted for 19 per cent, 4 per cent and 13 per cent, respectively of the gross advances of banks and the combined contribution of the three sectors to the incremental gross outstanding credit was to the extent of 40 per cent.

“Each of these sectors were characterized by unique asset quality features and, given their large share in credit portfolio of banks, required careful monitoring,” the report noted.

On real estate loans, which registered a growth of 24.6 per cent in 2010-11, more than the overall credit growth of 22.6 per cent, the financial stability report said the sector posed some concerns given the large and growing share of these loans in the credit portfolio of banks. “Going forward, the asset quality in this segment may come under further pressure given the increasing interest rate environment. There is also some anecdotal evidence of increasing inventory levels in the sector even as prices continued to remain elevated,” it observed.

Banks have also been told to monitor the rise in growth of retail loans. Here the worry is that bad loans in this category could rise as interest rates keep rising. “The robust rebound in retail loans witnessed during recent quarters warrants close monitoring as the asset quality of such loans could come under pressure given the increasing interest rate environment. The performances of these loans are closely linked to the individual income and wealth levels, which could be affected if the risks to economic growth were to materialise,” the report said.

Admitting that the elevated inflation and interest rate may also impact the balance sheet of financial entities, the report said the central bank needed to manage the volatility in the liquidity situation in the financial system which had been in a deficit mode for almost a year.