The Reserve Bank of India's second Financial Stability Report is generally positive. Maintaining and monitoring financial stability has always been a key objective of monetary policy. However, it was only from the middle of 2009 that the government and the RBI sought to institutionalise the process, making financial stability “an integral driver of the policy framework.” Accordingly, the RBI set up a Financial Stability Unit in August 2009 and started presenting periodical reports since March 2010. The first report found the banking system to be broadly healthy and well-capitalised, but noted that global economic shocks, inflation, the slow pace of fiscal consolidation and the unsettlingly large capital inflows posed significant risks to financial stability. According to the second FSR, many of the positive features are intact. Growth has rebounded strongly and the financial conditions are stable. Despite intermittent volatility in the foreign exchange and equity markets, the financial sector has been risk-free. New risk assessment measures introduced by the RBI — such as the Financial Stress Indicator and the Banking Stability Index — corroborate the central bank's generally positive assessment.
At the same time, the report also points to some significantly higher risks. Among them are: the widening current account deficit; volatile capital inflows; deterioration in some key external sector ratios; and the persistently high inflation. The asset quality of banks and their asset-liability mismatch need to be constantly monitored. Recent developments in the microfinance institutional structure cause serious concern. Given the increasing correlation between global economic growth and that in emerging markets, the possibility of certain exogenous risks materialising is strong. The finance channel has assumed greater importance in transmitting the pace and severity of the impact of disturbances abroad. The proposed capital rules pose some regulatory challenges. Implementing international norms calibrated to local conditions will require concerted efforts. However, given its inherent soundness, the banking system is unlikely to be stretched unduly.
