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 non-performing assets (NPA) ratio of all major sectors weakened during 2012-13. While the primary driver of 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 the 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 (CDR) mechanism.

In order to upgrade the banks' credit monitoring system, the Reserve Bank of India 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.

An analysis of the global banking system for 2012 shows a mixed picture. The financial conditions in the global banking system improved following monetary easing measures by central banks in advanced economics. Banks in the US are in an advanced stage of resuciating their balance sheets.

While the fundamentals of US banks are better as the asset quality has improved, concerns remain in the Euro zone banking system because of financial fragmentation. The Global Financial Stability Report (GFSR) of April 2013 noted that many Euro zone banking systems remain relatively weak. The capital buffers are low relative to the 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. Amid weak credit and economic growth, it is also faced with pressures on profitability, growing regulatory compliance costs and revenue-growth difficulties. The US Federal Reserve, in its September 18, 2013 communication, has surprisingly refrained from reducing the USD 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 (emerging market and developing economies) are better placed, as they have limited funding dependency on international markets. However, they too face downward risks arising out of deceleration in economic growth, capital outflows and forex market volatility.

The consensus was that banking systems in various countries should continue to strengthen 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.
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In light of this wisdom, the Reserve Bank of India 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 also not jeopardising the objective of reining 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. The headline Wholesale Price Index (WPI) inflation (YoY) averaged 7% in the second half of the year as against 7.7% in the first half. By March 2013, WPI inflation moderated to 5.7% on a point to point basis.

However, after easing in Q1 of 2013-14, WPI inflation started rising again. Retail inflation as measured by Consumer Price Indices (CPIs) also continued to remain elevated.

The RBI 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% of the 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% of the NDTL of banks in August 2012. Besides the liquidity injected through the daily liquidity adjustment facility (LAF) operations, the apex bank also purchased government securities worth Rs 1.5 trillion through open market operations (OMOs) during 2012-13.

During early 2013-14, the liquidity conditions generally improved mainly because of the drawdown of government cash balances and narrowing of the gap between deposit and credit growth.

On November 6, 2013, the Reserve Bank released the framework for setting up of Wholly-Owned Subsidiaries (WOS) by foreign banks in India. The policy framework is guided by the two cardinal principles of (i) reciprocity and (ii) single mode of presence. As locally incorporated banks, 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 framework states that banks with complex structures, those which do not provide adequate disclosure in their home jurisdiction, those 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. It incentivises the existing foreign bank branches to convert into WOS due to the attractiveness of near-national treatment.

Against the backdrop of the 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.