Indian banks pass stress test

MTM risks to the Indian banking sector are limited and manageable.

The Indian banking system is resilient to the shocks that may arise due to higher non-performing assets (NPAs) and the global economic crisis, the Reserve Bank of India’s (RBI’s) stress test has shown.

RBI’s Annual Report-2008-09 said the test was done to assess the capital adequacy of the banks to sustain losses from deteriorating asset quality, primarily due to falling external demand in the wake of the global recession a subsequent slowing of domestic private demand.

A similar test was done to assess the risks associated with the mark-to-market (MTM) losses on the banks’ overseas exposure. MTM means stating losses based on the current market value of the currency. The assessment, done in 2008, suggested that the MTM risks to the Indian banking sector appeared limited and manageable.

The exercise tested the banks’ exposure to seven sectors whose prospects have dampened due to the slowdown in external demand.

The sectors were chemicals/dyes/paints, leather and leather products, gems and jewellery, construction , automobiles, iron and steel, and textiles. These account for 15.4 per cent of total advances and 12.2 per cent of gross NPAs of Indian banks. The test assumed 300 per cent and 400 per cent simultaneous rise in NPAs in these sectors and adjusted the additional provisioning requirements from existing capital and risk-weighted assets. Barring two banks, which accounted for 3 per cent of the total assets of the banking system, others were found to have the strength to withstand such a risk.

In September 2007, following the financial crisis in the US, RBI started a monthly reporting system to capture the banks’ overseas exposure to off-balance sheet items (primarily credit derivatives and investments such as asset-backed commercial papers and mortgage-backed securities). An analysis of such information so far has revealed that the banks’ exposure to such instruments has gradually come down from June 2008. The MTM losses, however, gradually increased up to March 2009, reflecting the impact of the sustained fall in value of the assets.