With the economy slowing and India Inc’s debts looking worrying with the rupee slipping the way it is, it is not surprising RBI’s latest Financial Stability Report (FSR) should say macro risks have risen over the past 6 months. The ratio of India’s short-term debt to forex reserves, for instance, has risen by nearly half between March 2011 and December 2012, from 21% to 31%. That said, what’s comforting is RBI’s tests show the financial system is well equipped to handle even fairly severe stress levels.
The report, however, does point to some issues that call for more prudence. In the case of banks, while RBI’s baseline case estimates expected losses to rise from 2% of advances right now to 2.1% by March 2014, the baseline case for unexpected losses is as high as 7% — while this is undoubtedly a tail risk, the RBI thought it important enough to say “therefore it would be prudent for the (banks) to increase their provisioning from the present levels”. In the case of construction loans, for instance, RBI’s baseline scenario sees NPAs rising from 4% now to 4.8% by March, and from 1.5% in the case of infrastructure to 2.2% — while it is difficult to see which loans can go bad, the chances of SEB loans going bad seem the highest given the current restructuring scheme is based on the premise that banks will put their foot down and ensure tariffs are raised regularly. In such a situation, ideally it should have been RBI that raised provisioning, but at a time when there is pressure to lower interest rates, it’s possible RBI prefers the banks exercise their own judgment. Other areas that require attention are the exposure of insurance and mutual funds to banks — much of the Rs 6.5 lakh crore lending by these two sectors is to banks. In the case of insurance, as the RBI pointed out in the aftermath of the Cobrapost expose, the fact that banks make money selling insurance — Rs 2,000 crore of commissions in FY12 — creates it own complications. The FSR doesn’t talk of the systemic problem in the co-operative-commercial bank link the RBI talked of earlier and while talking of the problem with government pensions ballooning, the exclusion of the EPFO which has a far more serious problem with pensions is curious.