Report on Trend and Progress of Banking in India 2012-13

The economic and financial environment in which the Indian banking system is operating is evolving continuously. Developments in global banking are likely to be conditioned by proposed regulatory changes aimed at ring-fencing commercial banking activities. The Financial Sector Legislative Reforms Commission (FSLRC) has suggested a number of changes in the landscape of the financial sector.

The NPA ratio of all major sectors weakened during 2012-13. While the primary driver of the deteriorating asset quality was the domestic economic slowdown, the contribution of other factors like delays in obtaining statutory and other approvals as well as lax credit appraisal/monitoring by banks was also significant. Further, credit concentration in certain sectors and higher leverage among corporates also increased stress on asset quality. In recent years there has also been a sharp increase in the amount of debt restructured under the corporate debt restructuring mechanism. In order to upgrade the banks' credit monitoring system, the Reserve Bank advised them to have a robust mechanism for early detection of signs of distress and to use such early warning signals to put in place an effective preventive asset quality management framework. Going forward, it is anticipated that the position may improve if there is a pick-up in the GDP growth rate coupled with an improvement in project implementation due to the Government's efforts and improvements in banks' recovery efforts.

Financial conditions in the global banking system improved following monetory easing measures by central banks in advanced economics. Banks in the US are in an advanced stage of repairing their balance sheets. An analysis of the global banking system for 2012 shows a mixed picture. While the fundamentals of US banks are better as asset quality has improved, concerns remain in the euro area banking system because of financial fragmentation. The Global Financial Stability Report (GFSR) of April 2013 noted that many euro area banking systems remain relatively weak as capital buffers are low relative to reported impaired loans, the asset quality continues to deteriorate and profitability is poor. The global banking system is faced with multiple risks in the years ahead, as it is faced with pressures on profitability, growing regulatory compliance costs, and revenue-growth difficulties amid weak credit and economic growth. The US Federal Reserve in its September 18, 2013 communication has surprisingly refrained from reducing the US$ 85 billion pace of monthly buying, as it has decided to await more evidence that progress will be maintained before adjusting the pace of its asset purchases. Banks in EMDEs are better placed, as they have limited funding dependency on international markets, but they too face downward risks arising out of deceleration in economic growth, capital outflows and forex market volatility. Banking systems in various countries should continue strengthening their balance sheets. Timely completion and implementation of regulatory reforms will make banking systems less risky, more resilient and reduce future stability risks in the systems.

The Reserve Bank continued to fine-tune its prudential and supervisory policies to ensure that the banking system remained sound, resilient and inclusive. In order to achieve this objective, several policy measures were initiated. The monetary policy stance during 2012-13 was geared towards addressing the sharp slowdown in growth while not jeopardising the objective of reigning in inflation. There was a front-loading of easing of the key policy rate, the repo rate, by 50 basis points in April 2012. Reflecting the transmission of earlier monetary policy tightening as also the beneficial impact of fiscal consolidation, a moderation in inflation was witnessed in the second half. Headline Wholesale Price Index (WPI) inflation (y-o-y) averaged 7.0 percent in the second half of the year as against 7.7 percent in the first half. By March 2013, WPI inflation on a point to point basis, moderated to 5.7 percent. After easing in Q1 of 2013-14, WPI inflation started rising. Retail inflation as measured by Consumer Price Indices (CPIs) also continued to remain elevated. The Reserve Bank undertook a number of measures for liquidity management. The cash reserve ratio (CRR) was reduced in three stages by a cumulative 75 basis points in 2012-13, taking it to 4.0 percent of net demand and time liabilities (NDTL) of banks, its lowest level since 1974. The statutory liquidity ratio (SLR) was reduced by 100 basis points to 23.0 percent of NDTL of banks in August 2012. Besides the liquidity injected through the daily liquidity adjustment facility (LAF) operations, the Reserve Bank purchased government securities worth Rs. 1.5 trillion through open market operations (OMOs) during 2012-13. During early 2013-14, liquidity conditions generally improved mainly because of drawdown of government cash balances and narrowing of the gap between deposit and credit growth.

The Reserve Bank released the framework for setting up of Wholly Owned Subsidiaries (WOS) by foreign banks in India on November 6, 2013. The policy framework is guided by the two cardinal principles of reciprocity and single mode of presence. As a locally incorporated bank, the WOSs will be given near national treatment which will enable them to open branches anywhere in the country at par with Indian banks. The policy incentivises the existing foreign bank branches to convert into WOS due to the attractiveness of near national treatment. The policy framework states that banks with complex structures, banks which do not provide adequate disclosure in their home jurisdiction, banks which are not widely held, banks from jurisdictions claim to depositors of home country in winding up proceedings etc would be mandated entry into India only in the WOS mode.

Against the backdrop of a slowdown in the domestic economy and tepid global recovery, the growth of the Indian banking sector slowed down for the second consecutive year in 2012-13. In the short-term, the Indian banking sector needs to lend support to productive sectors facilitating economic recovery, while remaining vigilant about asset quality. In the medium to long-term, sustained improvements in efficiency and inclusiveness remain key areas of concern.