I’ndia’s financial sector faces ‘considerable challenges’, with high non-performing assets and slow repair of corporate balance sheets testing the resilience of its banking system and holding back investment and growth, a newly-released assessment by the International Monetary Fund (IMF) said on Thursday. “India’s key banks appear resilient, but the system is subject to considerable vulnerabilities,” the IMF said in a report, released after its Executive Board approved India's 2017 Financial System Stability Assessment (FSSA).
Citing stress tests, the report cautioned that that while the country’s largest banks were sufficiently capitalised and profitable to withstand a deterioration in economic conditions, a group of public sector banks were “highly vulnerable to further declines in asset quality and higher provisioning needs”. The Executive Directors, however, welcomed the important progress made by the Indian authorities in ‘strengthening financial sector oversight, deepening markets and fostering financial inclusion’. They also commended the major reforms undertaken since the last financial sector assessment in 2011, notably in introducing Basel III standards and risk-based supervision of banks and securities firms, improving inter-agency cooperation and introducing a modern insolvency framework for companies.
The Indian financial system, the IMF notes, is undergoing a gradual structural shift, with a greater role for non-bank 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 reflects banks’ assets,” it said. Taking note of the recent measures to recapitalise the public sector banks, including effective resolution of non-performing assets, the IMF directors have encouraged a broad-based restructuring of these banks with improved governance in order to avoid a resurgence of asset quality problems.
“Going forward, 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 noted.
Welcoming the planned introduction of a special resolution regime for financial institutions to improve incentives and reduce the potential risks to public resources that could arise from the failure of financial institutions, the directors urged the Indian authorities to continue with efforts to further align the proposed resolution framework and other components of the safety net with international standards and best practices.