India’s Financial Stability Report: Key Insights and Concerns

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The Reserve Bank of India’s latest Financial Stability Report indicates a positive trend in banks’ balance sheets, with low non-performing assets (NPA) ratio, strong capital buffers, and robust earnings. However, certain areas of concern demand close attention to ensure financial stability.

Key Concerns

The report highlights issues such as bad loans in the education segment, increased slippages from retail loans by private banks, and the interconnectedness between Non-Banking Financial Companies (NBFCs) and banks. Additionally, climate change-related risks are emerging as a significant concern for financial stability.

Improvement in Asset Quality

Commercial banks have shown a sustained improvement in asset quality, with the GNPA ratio falling to a 12-year low of 2.8 percent at the end of March 2024 from 3.2 percent in September the previous year. The NNPA ratio also decreased to 0.6 percent from 0.9 percent during the same period, and further improvement is expected under the baseline scenario.

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Reduction in Bad Loans

The reduction in bad loans is attributed to a combination of write-offs and a decrease in fresh bad loans. Notably, public sector banks recorded a substantial 76 percent reduction in their GNPA ratio in the second half of 2023-24, with a broad-based reduction in NPAs across sectors.

Concerns in Education and Retail Segments

The education segment has seen the highest default rate within the personal loans category, while slippages from retail loans, excluding housing loans, warrant monitoring, especially with private banks accounting for 40 percent of fresh additions to bad loans.

Capital Buffer and Stress Testing

Despite a moderation in the Capital to Risk-Weighted Assets Ratio (CRAR), Indian banks have sufficient capital buffers to handle stress. Stress tests by the RBI indicate that even under severe stress, banks’ capital will remain above the minimum requirement of 9 percent.

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Non-Banking Financial Companies (NBFCs)

NBFCs have seen a decline in their non-performing assets ratio, but concerns remain around their asset-liability profile and their potential spillover of risks to banks due to their significant reliance on bank funding.

Systemic Risk and Climate Change

The RBI’s Systemic Risk Survey identifies climate change-related risks and consumption demand as prime sources of risk to the Indian financial system, emphasizing the need for a comprehensive program to assess and address these risks.

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