Banks have ability to withstand stress

The Reserve Bank of India (RBI) today said the banking sector was in a position to withstand asset quality stress even if loans under restructured accounts became non-performing.

Following the global financial crisis, Indian banks were allowed, as a one-time measure, to restructure loans without classifying these accounts as sub-standard. The restructured accounts in the standard category constituted 3.1 per cent of the gross advances as on December 2009. “Stress tests indicate that the banking sector is comfortably resilient and, even if, in the worst-case scenario, it is assumed that all restructured standard advances become NPAs (non-performing assets), the stress will not be significant,” the central bank said in its Financial Stability report.

Although the stress tests result indicates that the impact on banks, following an unexpected rise in credit defaults, is not very significant, the central bank said there is a need to monitor the situation closely to identify any incipient signs of stress building up in the system.

In October 2009, RBI mandated banks to reach the provisioning coverage ratio of 70 per cent by September this year.

The stress tests result revealed that banks will be able to significantly withstand the impact of increased provisioning coverage norms of 70 per cent under a relatively adverse scenario. Though the banking system showed resilience to credit and interest rate shocks, the liquidity scenario could pose some potential threats, said the report.

“The liquidity stress tests result show that some banks face liquidity constraints under stress scenarios. Even though the scenarios have very stringent assumptions, nevertheless, the result of the stress tests suggest that banks need to continuously monitor their contingency liquidity plans while strengthening systems for managing the liquidity risk,” the report said.

RBI has noted that banks are increasingly relying on volatile liabilities to support balance sheet growth.

The share of core deposits to total assets has also progressively declined over the years (except in the last two quarters of 2009). The regulator cautioned that over-reliance on bulk deposits by certain banks could impact both cost and stability of their deposit base.

“Despite a high ratio of temporary assets to total assets, the coverage of liquid assets in relation to volatile liabilities has remained less than one, indicating a potential liquidity problem,” RBI said. “However, as banks maintain a minimum of 25 per cent of their NDTL in SLR securities, it would be possible to raise additional liquidity when required.”