Stable banking system, RBI regulations help avert SVB-like crisis in India: Finmin

The collapse of a few regional banks in the United States and the takeover of the crisis-hit Credit Suisse Bank by the Union Bank of Switzerland (UBS) have sent ripples across the global banking industry and posed fears of a contagion effect across economies.

The multifaceted nature of the RBI’s regulatory actions, improved bank balance sheets, and attunement of the banking system to frequent interest rate cycles augur well for India’s financial stability and significantly reduce the probability of an SVB-like event from occurring in India, the finance ministry said.

“Apart from these regulatory requirements and actions, certain characteristics of the banking system will help reduce the probability of an SVB-like incident occurring in India. First, the RBI’s Basic Statistical Returns reveal that as of March 2022, 60.1 percent of India’s deposits are with Public Sector Banks (PSBs); 63 percent of total deposits are owned by households considered sticky retail customers; therefore, deposit withdrawals in this category will remain limited,” the monthly economic review for March released by the finance ministry stated on April 25.

Even as the global economy reel under unceasing inflationary pressures and the consequent monetary tightening, financial vulnerabilities have emerged at the forefront. The collapse of a few regional banks in the US and takeover of crisis-hit Credit Suisse Bank by the Union Bank of Switzerland (UBS) have sent ripples across the global banking industry and posed fears of a contagion effect across economies.

The event has also raised the pertinent question among policymakers on the vulnerability of their financial system to such a collapse, especially in Emerging Market Economies (EMEs) that may lack the fiscal space to calm financial markets with fiscal packages.

While incidents like these are bound to happen in a rapid tightening cycle amid an uncertain economic environment, an analysis of the Indian banking system reveals that the lenders appear well-placed to handle any stress emanating from the current tightening cycle, the report said.

“Indian banks don't hold a majority of their assets in the form of bonds. Instead, for the top ten banks in terms of asset size, loans constitute more than 50 percent of their total assets, making banks more immune to the rising interest rate cycle,” it said.

The macro-and micro-prudential measures in recent years by the RBI and the government have culminated in the enhancement of risk absorption capacity, thereby improving the banking system's stability.

“Asset-liability mismatch (ALM) is another threat that emerges as policy rates are hiked. ALM in banks is not an anomaly but is embedded in the revenue models of financial institutions to earn margin and hence is prevalent in the banking system of all countries. However, the extent of ALM and the regulatory and supervisory framework to manage the vulnerability arising out of it is crucial as it may expose banks to risks if short-term interest rates rise or if there is a sudden demand for liquidity. ALM build-up is not an onerous issue in the Indian banking system,” it said.

After a phase of recapitalisation and cleaning up of bank balance sheets during the past years, there is a visible improvement in various banking indicators. Despite having a major proportion of loans in the asset basket,

Net interest margin, an indicator of a bank’s profitability and growth for all major banks, is high, implying efficient investment by banks.

The ratio of net NPA to net advances has been low and showed a declining trend driven by lower slippages and reduction in outstanding GNPAs through recoveries, upgrades and write-offs. The capital adequacy ratio for top 10 major banks (based on asset size) has been well above the Basel III Norms.

“The interest rate cycles have been quite prominent in India, aligning with RBI's financial conditions and goal to maintain financial stability and manage inflationary pressures. The exposure and attunement to regular interest rate cycles have made Indian banks well equipped to handle the cycles. This is unlike the case in Advanced Economies (AEs) where long-term interest rates have been close to zero for an extended period of time. Therefore, financial participants expected the rates to remain at low levels. So, when rates went up sharply within a short time to curb inflationary pressures, vulnerabilities in the financial markets came to the fore,” the monthly economic review said.

Also, the spread between deposit rates and the policy rate in India is much lower compared to that in the US. This is because of the ultra-low policy rate that has prevailed since the global financial crisis.

Various measures have been taken, including the creation of an investment fluctuation reserve (IFR) to create a buffer to shield banks from adverse yield movements, uniform application of capital and liquidity requirements to all banks, irrespective of their asset size and exposure, provision of guidelines on governance in commercial banks, with the focus on dealing with the root cause of vulnerabilities, the finance ministry said.

“These factors will also help support the medium-term growth trajectory to remain on course. However, rising uncertainty leaves no space for complacency and dynamic risk identification and management will be critical, especially in the current credit upcycle,” it said.