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Stressed banks slowing growth

Imf cautions India aginst further declines in asset quality.

Stressed banks slowing growth
For the first time, India's Financial System Stability Assessment (FSSA) Report of IMF highlights vulnerabilities and challenges, holding back investment and growth. Until recently, China with its highly inflated financial sector system was seen to be sole major emerging market economy posing risks to global financial stability, in successive IMF mandated reports. China is taking some corrective actions.

Now, India, though with a relatively lower scale of global financial market interventions, has run into a massive build-up of non-performing assets (NPAs) for a large segment of public sector banks with a severe risks to the credit system affecting investment and growth. In a review, IMF notes since the 2011 Financial Sector Programme Assessment, India had recorded strong growth in both economic activity and financial assets, supported by important structural reforms and terms of trade gains.
Yet, IMF notes, the financial sector is facing considerable challenges, and economic growth has recently slowed down. "High nonperforming assets and slow deleveraging and repair of corporate balance sheets are testing the resilience of the banking system". The banking system is subject to considerable vulnerabilities.
While stress tests show that the largest banks are sufficiently capitalised and profitable to withstand a deterioration in economic conditions, a group of public sector banks (PSBs) are highly vulnerable to further declines in asset quality and higher provisioning needs.
Though Government has lately moved into an accelerated process of addressing the systemic crisis in public sector banks, in particular, with plans for recapitalisation of banks and announced procedures on enforcement of bankruptcy code etc, the latest IMF Assessment points to a wider range of capital needs from 0.75 per cent of GDP in the baseline to 1.5 per cent of GDP in the severe adverse scenario.
While welcoming the moves to accelerate the process of NPA resolution, such as reorganisation and insolvency resolution in a time-bound manner, and empowering RBI with directing restructuring cases to the insolvency process, IMF says this holds promise to deliver progress in NPA resolution, particularly if accompanied by sufficient upfront provisioning and capital buffers in the PSBs and other policy measures.
These include a broader restructuring of the PSB sector, including improvements in governance; more flexible out-of-court debt restructuring mechanisms; and increased capacity and resources for the insolvency courts. IMF noted recapitalisation plan for the PSBs amounted to approximately 1.3 per cent of GDP, while a mechanism is established to seek consolidation across these banks.
There are still unstated or invisible risks to bringing about a smooth provisioning of key banks and more in the evolution of a restructured banking system in the public sector. There may not be any attempt in privatisations, given the turn of developments in the wake of Gujarat elections outcome, with its own shocks and lessons to the ruling dispensation at the Centre.
According to IMF, the Indian financial system is undergoing "a gradual structural shift, with a greater role for nonbank intermediaries and higher recourse to market funding for large corporates." Financial system assets equal about 136 per cent of GDP, close to 60 per cent of which reflect banks' assets. The state retains "an important footprint in the system via ownership of large financial institutions, captive government financing, and directed credit to priority sectors".
The IMF Financial System Assessment Programme noted considerable progress made in strengthening financial sector oversight, and one of its identified areas with scope for further improvement remains. Notably, these include strengthening the RBI's de jure independence as well as its powers over the PSBs.
In their overview of FSSA Programme on India, the Executive Directors were of view that greater participation of the private sector in bank capital, a "smaller footprint of the public sector" in the financial system, a cautious reduction in statutory liquidity requirements, and assessing the effectiveness of directed lending, would boost the system's capacity to support credit to the economy, while reducing moral hazard and contingent fiscal liabilities.
The Report has a series of recommendations such as improving the governance and financial operations of PSBs and developing a strategic plan for their consolidation, divestment, and privatisation. The Crisis management framework − Resolution legislation should preserve RBI's full supervisory authority over going concern banks, and promote equal treatment of domestic and foreign creditors.
(The views expressed are strictly personal.)

S. Sethuraman

S. Sethuraman

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