Global headwinds to impact banking sector stability

Higher funding costs and asset quality pressures take a toll on the sector’s health.

The slowing domestic economy and strong global headwinds may further increase loan defaults and funding costs of the Indian banking sector, according to the Reserve Bank of India (RBI)’s Financial Stability Report.

However, the report said despite the deterioration, the health of the sector was robust.

The banking sector faced profitability issues due to higher funding costs and asset quality pressure, owing to a slowing economy. A forecast by the banking stability indicator for the next two quarters shows a continuing a marginal deterioration in stability.

Credit growth decelerated from 22.6 per cent as of end-March to 19.2 per cent as of end-September. The gross non-performing assets (NPAs) ratio of 2.8 per cent is broadly in line with the average in peer countries.

The growth of NPAs at 30.5 per cent and that of slippages at 92.8 per cent outpaced the credit growth of 19.2 per cent end-September. The priority sector, real estate, infrastructure and retail sectors contributed significantly to the rise in NPAs. The power and telecom sectors together accounted for 77 per cent of infrastructure credit and saw a rise in impairments and restructuring.

Capital adequacy, though well above the regulatory requirement, continued to decline, falling from 14.5 per cent as on end-March 2010 to 13.5 per cent as of end-September.

Banks’ profitability has come under pressure, as rising interest rates resulted in the growth of interest expenses outpacing that of interest income, and a consequent deceleration in net interest income and earnings.

The turmoil in the euro zone has fanned fears of deleveraging by the European banks. Indian banks are not expected to see any direct impact, on account of negligible exposure to the troubled area. However, some indirect impact due to funding pressures could be seen.