RBI’s 29th Financial Stability Report (FSR) July 2024: An Overview

The Financial Stability Report (FSR) is a comprehensive, half-yearly publication that involves contributions from all financial sector regulators in India. It reflects the collective assessment of the Sub-Committee of the Financial Stability and Development Council on current and emerging risks to the stability of the Indian financial system. The July 2024 edition of the FSR highlights various aspects of global and domestic macro financial risks, the soundness and resilience of financial institutions, regulatory initiatives, and an assessment of systemic risk.

Global Macrofinancial Risks

The global economy and financial system demonstrate resilience amidst significant risks and uncertainties. Despite the improvement in near-term prospects, several factors pose downside risks:

• Disinflation Pitstops: Challenges in achieving the last mile of disinflation.
• High Public Debt: The rising levels of public debt across nations.
• Stretched Asset Valuations: Overvaluation of assets in financial markets.
• Economic Fragmentation: Growing economic divisions among countries.
• Geopolitical Tensions: Persistent geopolitical conflicts and their economic impacts.
• Climate Disasters: Increasing frequency and severity of climate-related disasters.
• Cyber Threats: Rising threats from cyber-attacks and security breaches.

Emerging market economies (EMEs) remain particularly vulnerable to these external shocks and spillovers.

Domestic Macrofinancial Risks

India’s strong macroeconomic fundamentals and a stable financial system have underpinned the sustained expansion of its economy. Key factors supporting this growth include:

• Moderating Inflation: A trend of decreasing inflation rates.
• Strong External Position: Robust foreign exchange reserves and favorable trade balances.
• Fiscal Consolidation: Ongoing efforts to reduce fiscal deficits and manage public debt.

These factors have bolstered business and consumer confidence, with domestic financial conditions further strengthened by the healthy balance sheets of financial institutions.

Financial Institutions: Soundness and Resilience

Scheduled Commercial Banks (SCBs)

SCBs have shown remarkable improvement in profitability and asset quality:

• Profitability: Return on assets (RoA) and return on equity (RoE) are at 1.3% and 13.8%, respectively.
• Non-Performing Assets (NPAs): Gross NPAs and net NPAs are at multi-year lows of 2.8% and 0.6%, respectively.
• Capital Buffers: The capital to risk-weighted assets ratio (CRAR) and the common equity tier 1 (CET1) ratio stand at 16.8% and 13.9%, respectively, well above the regulatory minimum.

Macro stress tests for credit risk indicate that SCBs have adequate capital buffers to withstand adverse stress scenarios.

Urban Co-operative Banks (UCBs) and Non-Banking Financial Companies (NBFCs)

• UCBs: The CRAR for UCBs increased to 17.5% in March 2024.
• NBFCs: The CRAR for NBFCs slightly declined to 26.6%, still significantly above the regulatory minimum.

The insurance sector’s consolidated solvency ratio remains above the minimum threshold limit of 150%, and stress tests on mutual funds and clearing corporations indicate robust resilience.

Regulatory Initiatives and Other Developments in the Financial Sector

Global Initiatives

Regulatory efforts globally continue to focus on:

• Promoting financial stability.
• Consistent implementation and refinement of global standards.
• Safeguarding the banking system from interconnectedness with non-banking financial institutions.
• Addressing risks from the digitalization of finance.
• Improving climate-related risk assessments.
• Strengthening resilience to cyber risks.

Domestic Initiatives

In India, regulatory initiatives aim to enhance the safety and resilience of the financial system by:

• Implementing proportionate regulations.
• Leveraging technology to improve customer service, governance, and risk management.
• Limiting procyclical activities while fostering efficiency.

Assessment of Systemic Risk

The most recent systemic risk survey (SRS) conducted in May 2024 categorized all major risk groups to domestic financial stability as ‘medium.’ Key findings include:

• Optimism in Domestic Financial System: Respondents showed optimism regarding the soundness of India’s financial system.
• Global Spillover Risks: Risks from global spillovers have diminished, with increased confidence in the Indian financial system.
• Near-term Risks: The main near-term risks identified were geopolitical risks, tightening of global financial conditions, and capital outflows.

Highlights of the Reports

• The global economy is facing heightened risks from prolonged geopolitical tensions, elevated public debt, and the slow progress in the last mile of disinflation. Despite these challenges, the global financial system has remained resilient, and financial conditions stable.
• The Indian economy and the financial system remain robust and resilient, anchored by macroeconomic and financial stability. With improved balance sheets, banks and financial institutions are supporting economic activity through sustained credit expansion.
• The capital to risk-weighted assets ratio (CRAR) and the common equity tier 1 (CET1) ratio of scheduled commercial banks (SCBs) stood at 16.8 per cent and 13.9 per cent, respectively, at end-March 2024.
• SCBs’ gross non-performing assets (GNPA) ratio fell to a multi-year low of 2.8 per cent and the net non-performing assets (NNPA) ratio to 0.6 per cent at end-March 2024.
• Macro stress tests for credit risk reveal that SCBs would be able to comply with minimum capital requirements, with the system-level CRAR in March 2025 projected at 16.1 per cent, 14.4 per cent and 13.0 per cent, respectively, under baseline, medium and severe stress scenarios. These scenarios are stringent conservative assessments under hypothetical shocks and the results should not be interpreted as forecasts.
• Non-banking financial companies (NBFCs) remain healthy, with CRAR at 26.6 per cent, GNPA ratio at 4.0 per cent and return on assets (RoA) at 3.3 per cent, respectively, at end-March 2024.