The Reserve Bank of India's Financial Stability Reports (FSRs) are half-yearly assessments of the health of the financial sector. Of a comparatively recent origin, the FSR is intended to bring India's financial regulatory practices in line with the best in the world. Its key objective is to monitor and sustain the health of the financial sector. The RBI gives out its assessments and views at varied intervals through documents called variously as reports, policy statements, and reviews. For its part, the FSR distinctively focusses on the systemic aspects, rather than the individual components, of the financial sector and evaluates the soft spots in the Indian scene. Lessons are sought to be learnt from the interplay of the macroeconomic setting, policies, markets and institutions, for which the central bank claims to use the most up-to-date techniques and methodology. According to the latest FSR covering June-December 2011, the domestic financial system remains robust. The banking system is resilient enough to tide over unexpected adverse macroeconomic developments. But the good news, which is carried over from the previous FSR, was tempered by evidence of some deterioration in the macroeconomic environment and financial markets.

Notably, all components of domestic demand have decelerated. Inflation pressures remain elevated, driven by a number of factors. Risks to the external sector have increased. Trade deficit and, along with it, the current account deficit have widened. The fiscal position remains challenging and, as the recent additional demand for supplementary grants shows, the risk of fiscal slippages is real. Equity and financial markets continue to be volatile, mainly due to adverse developments abroad. Exchange depreciation, which has been particularly sharp, is beginning to impact the Indian economy through various channels. There have been large transaction losses on foreign exchange exposures. Repayment of external commercial borrowings has become more expensive. Among financial institutions, the FSR shows some deterioration in financial soundness indicators, but capital adequacy stays well above regulatory requirements, and asset quality compares favourably with what obtains in peer countries. As the year progresses, the slowdown in GDP growth will make the Indian financial sector more vulnerable. Banks will have simultaneously to address the related challenges of lower asset quality and raising additional capital, the latter also to comply with the Basel III requirements. The FSR once again gives a clean chit to the Indian financial sector, but warns of troubles ahead.

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