inflationary pressures, increase fiscal deficit and weaken the balance-sheet of Corporate India. 7. Interconnectedness. The interconnectedness of institutions or markets has increased due to globalization, financial innovations, business strategies, technology and product characteristics. Traditional risk measurement approaches do not consider the interconnectedness. Despite these risks, the overall stability of the financial system remained robust with a sound banking system and a good regulatory architecture. The long term growth prospects of Indian economy look reasonably optimistic. Indian economy is one of the fastest growing economies in the world. Services sector was a major contributor and continues to be a positive contributor in the domestic outlook. Improved savings and investment rates, favorable financial market conditions, increase in capital flows, moderating inflation and positive business outlook would help the economy to broad-base the growth momentum in the long term. However, the medium term growth prospects depend largely on external macro economic conditions and proactive domestic policies. While incomplete models of risk dynamics and a transforming global financial system make detection of systemic crisis difficult, attempts can-and infact should- be made to identify the emerging pattern and initiate a broad spectrum of measures to discernibly improve the ground realities to meet ubiquitous risks to overall domestic macroeconomic prospects. INDIAN BANKING SYSTEM AND SYSTEMIC RISKS Despite the global financial meltdown, the Indian banks have displayed great strength and resilience and remained immune to major systemic crises. While Indian banks are well capitalized, the macro- economic slowdown has resulted in emergence of some risks in the banking sector. Some risks in Indian banking sector in the transforming socio-economic milieu, which could have systemic implications are: 1. Asset Quality. An increase in slippage ratios, rise in the quantum of restructured assets and a high rate of growth in Non Performing Assets (NPAs) relative to credit growth implied that the concerns on asset quality of banks remain elevated. Gross NPAs for SCBs increased to 2.9% as at end March 2012 (2.4% at end March 2011). Q 1 Review of
the performance of Scheduled Commercial Banks (SCBs) reveals a clear divergence in the earnings of private banks and pubic sector banks (PSBs). While the asset quality of PSBs has deteriorated, private banks have posted robust earnings growth driven by stronger topline (+25% yoy) and stable asset quality. In Q1, loans and advances grew strongly for both PSBs and private banks at +18% average for PSBs and ~24% for private banks. This growth partly benefited from rupee weakness for several important banks with significant global footprints. Domestic growth has been fairly modest at 15-17%, which also has been driven by agriculture and retail. Margins for most PSBs have been impacted partly due to higher slippages leading to interest reversals on loans and also due to rise in funding costs.
2. Low deposit growth despite high interest rates. Less than 14%, the deposit growth rate as on March 31, 2012, which is the lowest recorded in the last decade, had forced banks to rely more on borrowed funds resulting in future liquidity risks. In view of the serious crisis and the intensity and speed with which systemic problems spread to other markets, the scope for monitoring of financial markets has increased. Repeated market turbulences also demonstrate that promotion of financial stability is a collective responsibility of various financial market regulators. Central Banks, prudential regulators and other regulatory controllers have an important role to play in identifying potential systemic risks and stabilizing financial markets through durable reforms. This,
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