The Reserve Bank of India (RBI), on Friday, said that the risks to banking sector had been increasing in recent years with a continued deterioration in the stability of the banking sector since 2010. It also said that the aggregate risks remained at an elevated level during 2012.

“An analysis of the components contributing to banking stability show that tight liquidity, deteriorating asset quality and reducing soundness are the major contributors to the decline in stability of the banking system,” the RBI said in its Financial Stability Report (FSR) 2012.

However, it said that a marginal improvement in the indicator during the last two quarters was observed primarily because of better liquidity condition, due to regulatory prescriptions and enhanced profitability ratios, arising out of lower provisioning coverage.

The Banking Stability Map, which reflects the relative changes in the vulnerabilities since the previous FSR, further reveals that the asset quality and soundness indicators have deteriorated vis-à-vis their position in March 2012, while the liquidity indicators show some improvement as at the end of September 2012. The profitability indicators in the current quarter, though better than March 2012, show marginal deterioration as compared to June 2012

Total bank credit grew at 15.9 per cent, while total deposits growth was 14.3 per cent as at end September 2012 (year-on-year). Despite faster credit growth relative to deposit expansion, the credit-deposit (C-D) ratio has declined to 74.4 per cent as at end September 2012 from 76.0 per cent as at end March 2012.

“The incremental C-D ratio has also declined during the half-year since March 2012, indicating the trend that banks have deployed a greater share of incremental deposits in investments and other assets,” said the RBI.

The steepest fall in growth rate of gross advances (year-on-year) as at end-September 2012 from the previous quarter was for the foreign banks; from 17.3 per cent to 6.5 per cent, followed by old private sector banks from 23.1 per cent to 18.6 per cent. There was a moderate fall in the growth rate of advances for public sector banks to 15 per cent, while the new private sector banks had a slight increase in the growth rate of advances at 22.7 per cent.

The asset quality of banks has seen considerable deterioration during the half-year under review. Gross non-performing advances (GNPA) ratio for all banks rose sharply to 3.6 per cent from 2.9 per cent. Net NPA ratio stood at 1.7 per cent as against 1.2 per cent.

The concerns on asset quality are also underscored by the increasing trend in the slippage ratio as well as ratio of slippages to actual recoveries (excluding upgradations).

“Except for foreign banks, these ratios increased for all bank groups since March 2011. However, slippage to recovery ratio for all the bank groups improved marginally during the quarter ended September 2012. With the growth rate in GNPAs continuing to tread well above the credit growth and movements in slippages remaining upward, the profitability of banks may come under pressure in the coming quarters,” the RBI said.

Restructuring of loans, particularly of big ticket loans, under the corporate debt restructuring (CDR) mechanism, has recently come under closer scrutiny due to the steep rise in the number and value of such advances.

Between March 2009 and March 2012, while gross advances grew by less than 20 per cent (compounded annual growth rate), the restructured standard advances grew by over 40 per cent. The proportion of restructured standard advances to gross advances increased from 3.5 per cent in March 2011 to 4.7 per cent in March 2012. This has further increased to 5.9 per cent as at the end of September 2012.

The apex bank further said that the pressure on asset quality in the power sector had worsened since FSR 2011. “Impairments have risen in the preceding year ending September 2012. Instances of restructuring, too, have registered a steep increase in the recent quarters. The large exposure to this sector remains an area of concern for banks.”

Tight liquidity, deteriorating asset quality contribute to the decline in stability of the banking system