Key Findings of Financial Stability Report (FSR)

The Reserve Bank of India (RBI) has published the Financial Stability Report (FSR) for December 2024, presenting an in-depth assessment of the health and stability of the Indian financial system.

What is Financial Stability Report?

The FSR is released twice a year, in June and December, providing crucial insights into the stability, resilience, and risks within the financial sector. It is published after approval from the FSDC Sub-Committee (Financial Stability and Development Council). The report incorporates insights from major financial sector regulators, including RBI, SEBI, PFRDA, IRDAI and Finance Ministry. The objectives of the report include:

2. Review the nature, magnitude, and implications of risks affecting the macroeconomic environment, financial institutions, markets, and infrastructure.
3. Ensure financial sector resilience by conducting stress tests.

Key Findings of the December 2024 Report

Current Economic Context

Real GDP growth moderated to 6% during the first half of 2024-25, down from 8.2% in the previous year. Despite this slowdown, structural growth drivers remain intact, indicating potential recovery in the latter half of the fiscal year.

Banking Sector Resilience

Scheduled Commercial Banks (SCBs) have shown improved asset quality, with the Gross NPA ratio falling to a 12-year low of 2.6%. Strong profitability and adequate capital buffers enhance the soundness of these banks. Stress tests confirm that SCBs can maintain capital above regulatory requirements even under adverse conditions.

Inflation and Food Prices

Retail inflation decreased to 5.5% in November 2024, aided by softer food prices and a favourable base effect. However, extreme weather events pose risks to food inflation dynamics. The upcoming kharif and rabi harvests are expected to further ease food prices.

Impact of AI on Financial Stability

The adoption of Artificial Intelligence (AI) in the financial sector introduces risks such as market concentration and increased cyber threats. Regulators are advised to balance the benefits of AI with the need to safeguard the financial system.

Equity Market Trends

There is a notable demand-supply mismatch in equity issuances, with domestic investors favouring short-term returns. Despite rise in trading activity, many individual investors have experienced losses in the derivatives market.

Concerns in Private Banking

Rising write-offs, particularly among private banks, could mask deteriorating asset quality. The report indicates that unsecured loans are source of new NPAs, raising concerns about underwriting standards.

Future Economic Outlook

The RBI anticipates a recovery in GDP growth driven by domestic consumption and investment. The overall stability of the financial system, characterised by healthy balance sheets, supports this optimistic outlook.

Future Projections on NPAs Gross bad loans may rise to 3% by March 2026 in normal conditions and up to 5.3% under high-risk situations. Despite this, all banks are projected to maintain their capital adequacy ratio above the 9% regulatory minimum.

Liquidity Challenges

The banking system is facing a liquidity shortfall, which has reached ₹2.43 trillion as of December 2024. This deficit is driven by tax outflows and forex interventions. Steps like bond purchases and CRR cuts might help address the issue.

Improved Regulatory Compliance

Penalties imposed by the RBI on banks and institutions dropped by 47%, signaling better adherence to regulations. Fines totaled ₹30 crore compared to ₹57 crore during the same period last year.

Strengthening of NBFCs

Non-Banking Financial Companies (NBFCs) have healthier balance sheets. Stress tests reveal they can maintain capital levels well above the required minimum, even in challenging scenarios.

GKToday Notes:

1. Financial Stability Report (FSR): FSR is a half-yearly publication by the Reserve Bank of India. It assesses the resilience of the financial system and identifies risks to stability.
2. Gross Non-Performing Asset (GNPA): GNPA refers to loans that are in default. The ratio indicates asset quality, with a lower GNPA suggesting improved financial health in banks.
3. Non-Banking Financial Companies (NBFCs): NBFCs are financial institutions that provide banking services without meeting the legal definition of a bank. They play important role in financial inclusion and credit provision.
4. Kharif and Rabi Crops: Kharif crops are sown with the onset of monsoon, while Rabi crops are sown in winter. Both impact food prices and inflation dynamics in India.