The ninth edition of the Reserve Bank of India’s Financial Stability Report (FSR), a bi-annual publication, reflects the collective assessment of an expert sub-committee on risks to financial stability. The periodic publication of such reports by the RBI is in line with best practices around the world for major central banks. As in the case of previous editions, the recent FSR aims to promote awareness about vulnerabilities in the financial system. Other important objectives are to examine the resilience of the financial institutions and to encourage a debate on the development and regulation of the financial sector. Most of these objectives are also currently being examined at the highest levels of the government and the RBI, in many cases with the help of expert groups. For instance, bank governance, which has a substantial bearing on financial sector stability, has been dealt with extensively by the P.J. Nayak Committee whose report is now being discussed at several levels. The deteriorating asset quality of public sector banks (PSBs) can affect financial sector stability. Although issues of recapitalising them and their ownership are within the domain of government policy, the FSR points out that there is a case to review the governance structures of PSBs with a greater emphasis on market discipline.
On the positive side, the FSR notes that by many yardsticks the level of capital with commercial banks remains well above the regulatory minimum even under adverse macroeconomic conditions. The post-election scenario marked by political stability has improved the economic outlook. The government is in a better position to resolve supply-side issues and help the RBI in its battle against inflation. The capital markets reflect the expectations on policy measures to address the adverse growth-inflation dynamics and saving-investment balance as also efficient implementation of policies and programmes. At the global level, the financial markets are showing signs of improved stability although economic growth has not picked up uniformly everywhere. Easy monetary conditions prevail in many jurisdictions. Their potential unwinding can pose a threat to financial stability in many emerging markets. Perhaps for the first time a stability report has called for a vigil over “shadow banking entities”, which are inaccurately perceived as being regulated by the RBI. There is an urgent need to eliminate ambiguities relating to these entities. The FSR calls for better monitoring of the lending operations of insurance companies and the money-spinning treasury operations of large corporations. The issues flagged by the FSR will have to be addressed in the budget and the RBI’s credit policies.