Banking system 'strong enough to survive' policy rate changes: FinMin study

Probability of event like Silicon Valley Bank's collapse in the US happening in India significantly less, says ministry's monthly review

India’s banking system is "strong enough to survive" stress caused by interest rates increasing and it will continue aiding economic growth, said the Finance Ministry in its monthly economic review on Tuesday.

“The multifaceted nature of RBI’s regulatory actions, the improved bank balance sheets, and the attunement of the Indian banking system to frequent interest rate cycles place augur well for India’s financial stability and significantly reduce the probability of a Silicon Valley Bank (SVB)-like event occurring in India,” said the report for March, referring to the US lender’s collapse in February.

The report said measures by the Reserve Bank of India (RBI) and the government in recent years have improved the banking system's stability and risk absorption capacity. The RBI is meticulous in its bi-annual assessment of Scheduled Commercial Banks (SCBs) and Non-Banking Financial Companies (NBFCs) and cooperative banks.

"The frequent assessment of financial institutions by RBI ensures that vulnerabilities are identified even in smaller institutions, which may be impacted relatively more by monetary tightening and yield spikes," said the ministry’s report.

The Indian economy is estimated to grow at 7 per cent in FY23 despite the impact of the pandemic and geo-political conflict. "Growing macroeconomic stability, as seen in the improved current account deficit, easing inflation pressure, and a banking system strong enough to survive the increase in policy rates, has made the growth rate further sustainable."

Banks fundamentals

RBI data, as on March 2022, showed that about 60.1 per cent of India’s deposits are with public sector banks (PSBs). As many as 63 per cent of total deposits are owned by households, who are sticky retail customers and ensure withdrawals will be limited.  

The ministry report said that after a phase of recapitalisation and cleaning up of bank balance sheets during the past years, there is a visible improvement in various banking indicators. "The Net Interest Margin (NIM) of banks is high and there are lower slippages accompanied by reduction in outstanding Gross Non-Performing Assets (GNPAs) through recoveries, upgrades and write-offs," it added.

Indian banks don't hold a majority of their assets in the form of bonds making them more immune to the rising interest rate cycle.

"The exposure and attunement to regular interest rate cycles have made Indian banks well-equipped to handle the cycles, whereas in advanced economies long-term interest rates have been close to zero for an extended period of time and as rates went up sharply within a short time to curb inflationary pressures, vulnerabilities in the financial markets came to the fore."

"The spread between deposit rates and the policy rate in India is much lower compared to that in the US because of the ultra-low policy rate that has prevailed in the US since the global financial crisis. Since the spread is not as large in India’s case, withdrawal of deposits altogether remains an improbable event," it said.