Inter-connectedness between financial institutions needs closer monitoring

The Reserve Bank of India (RBI), on Thursday, said that concerns over the asset quality of banks remained elevated and that the growing inter-connectedness between financial institutions warranted closer monitoring of the ‘most connected’ banks.

“An increase in slippage ratios, rise in the quantum of restructured assets and a high rate of growth in non-performing assets (NPAs) relative to credit growth implied that the concerns on asset quality of banks remain elevated,” RBI said in its Financial Stability Report of June 2012.

The gross NPA ratio for scheduled commercial banks (SCBs) increased to 2.9 per cent as at end March 2012 (2.4 per cent at end March 2011). However, it said the position was not alarming at the current juncture and some comfort was also provided by the strong capital adequacy position of banks.

“Distress dependencies between banks have been on the rise, as evidenced by the trends in the Banking Stability Measures,” the RBI said.

The analysis of the network of the Indian banking system revealed that the maximum potential loss to the banking system due to the failure of the ‘most connected’ bank had risen during 2011. “These trends would need to be carefully monitored, through rigorous micro-prudential supervision of the ‘more connected’ banks,” it added.

Risks

The rapid growth of NBFCs engaged in lending against gold in recent years could pose risks due to the business model of such companies, concentration of business among a few companies and their growing inter-connectedness with the banking system. These risks were sought to be addressed through various regulatory prescriptions, it said.

The RBI further said that insurance companies and mutual funds were vulnerable to the risk of contagion from the banking system. “Insurance companies and mutual funds are the major lenders in the Indian financial system with banks, especially public sector banks, being the major borrowers.”

Banks, on the other hand, were considerably reliant on borrowings from these entities. As borrowings from mutual funds were largely short-term, the RBI said, “they could engender greater liquidity risks for the banking system.”

The central bank said that potential rating change could impact overseas borrowing of Indian corporates and banks.

The apex bank also said that implications of increasing use of algorithmic and high frequency trading needed to be watched. “Some recent episodes in Indian markets have highlighted the need for a carefully calibrated approach towards technological advancements.