India`s financial sector facing considerable challenges: IMF

Washington: India's financial sector is facing considerable challenges with high non-performing assets and slow deleveraging and repair of corporate balance sheets testing the resilience of the banking system and holding back growth, the IMF on Thursday said.

After its Executive Board discussed the Financial System Stability Assessment (FSSA) of India, the IMF in a report said India's key banks appear resilient, but the system is subject to considerable vulnerabilities.

"The financial sector is facing considerable challenges, and economic growth has recently slowed down. High non- performing assets (NPAs) and slow deleveraging and repair of corporate balance sheets are testing the resilience of the banking system, and holding back investment and growth," it said.

The last FSSA for India was done in 2011.

Conducted jointly by a team of the IMF and the World Bank, the Financial Sector Assessment Programme aims at having a very comprehensive and in-depth view of the financial system in countries with big systemic financial systems.

Stress tests show that while largest banks are sufficiently capitalised and profitable to withstand a deterioration in economic conditions, a group of public sector banks (PSBs) are highly vulnerable to further declines in asset quality and higher provisioning needs, the IMF warned.

Noting that the country's financial system is undergoing a gradual structural shift, with a greater role for non-bank intermediaries and higher recourse to market funding for large corporates, the IMF said financial system assets equal about 136 percent of GDP, close to 60 percent of which reflect banks? assets.

The state retains an important footprint in the system via ownership of large financial institutions, captive government financing, and directed credit to priority sectors, the IMF said.

Marina Moretti, IMF Assistant Director at Monetary and Capital Markets Department who led the FASP team, said the team saw a system in India that is evolving structurally.

"I would say slowly, but surely so, it is becoming less bank-dominated. A whole lot of the credit now is from non-bank sources and it is also becoming less state-dominated," she said, but quickly added that the state footprint in India is still very strong, primarily for two reasons ownership of financial institutions, and the largest institutional investors are state-owned.

Moretti told PTI that the 2011 FSSA had showed that vulnerabilities were building up in the financial sector. There was rapid credit growth, the underwriting standards in all these credits were not very clear and there was a lot of single name concentration, she said.

"That was 2011. We go this time and what we see is that these vulnerabilities have materialised. Now, some of these loans have gone bad and in some the banks are facing some kind of trouble," said Moretti, who was part of the 2011 FSAA process.

Moretti said that around, 2009, 2010 and 2011 there was a big push in infrastructure investment by corporates, which was financed by public sector banks.

"Then for a variety of reasons things did not turn out too well," she said.

The variety of reasons are multiple -- global economic downturn, some contraction in India, contraction in China as well as structural bottlenecks which essentially referred to which are particularly relevant for the infrastructure sector, delays in obtaining environmental permits and land acquisition that didn't fall through, she said.

So these loans took a toll on the corporates, projects were not completed and this turned into loans that were not being repaid, she added.

The FSAP took stock of the considerable progress made in strengthening financial sector oversight and identified areas where scope for further improvement remains.

Notably, these include strengthening the RBI's de jure independence as well as its powers over the PSBs; expanding other financial regulators resources; introducing a risk-based solvency regime and extending risk-based supervision for insurers; and unifying the oversight of commodities markets.

Other gaps include risks from politically exposed persons and the gold sector, the IMF said.

In the area of crisis management, the planned introduction of a special resolution regime for financial institutions is an important step toward aligning the financial safety net with international standards, although there is duplication of supervisory responsibility for going- concern institutions between supervisor and resolution authority; also, the proposed new framework does not ensure equal treatment of domestic and foreign liability holders in resolution, the IMF said.

There is scope to enhance other elements of the safety net, including deposit insurance, emergency liquidity assistance and crisis preparedness, it asserted.

Moretti said FSSA took a close look at the Financial Resolution and Deposit Insurance Bill.

Noting that the IMF is well aware of the current discussion on this in India particularly on the bailing tool of the depositors, she said it might be useful to know that currently, the deposit insurance scheme in India already covers in full some 93 percent of depositors.

"While this is a high percentage of fully insured accounts, it is important to review coverage levels on a regular basis. As financial inclusion accelerates and as the deposit base expands, these coverage rates will become obsolete," Moretti said.

"Introducing a special regime that gives the authorities powers to deal with bank failure is important. So this bill is a step in the right direction because it gives a range of powers," she said.

"We do believe that there is plenty of room for improvement in the bill and there are some recommendations in the FSSA in this area," Moretti said in response to a query.

Observing that the debate in India is related to the weaknesses of the public-sector banks, she said the FSSA team strongly believes that the government like any shareholder of banks, has a responsibility to honor the contracts of these banks and recapitalize the banks.

She added that the Financial Resolution and Deposit Insurance Bill is for the future and not to solve the problems of the present.

"We do believe that it is important that those resolution pools are put in place because if private banking is becoming more prominent then there is a need for the authorities to have tools to deal with banking problems and does not force them to bail those banks out. The bailout concept applies to private banks. For state-owned banks, they are the owners, they have the responsibility to recapitalise," Moretti said.

The IMF said the Indian authorities have been pursuing policies to accelerate the process of NPA resolution.

The 2016 Insolvency and Bankruptcy Code introduced a modern framework that aims at reorganisation and insolvency resolution in a time-bound manner, and the RBI was empowered with directing restructuring cases to the insolvency process.

"This approach shows promise to deliver progress in NPA resolution, particularly if accompanied by sufficient upfront provisioning and capital buffers in the PSBs; broader restructuring of the PSB sector, including improvements in governance; more flexible out-of-court debt restructuring mechanisms; and increased capacity and resources for the insolvency courts," the IMF said.

The authorities recently announced a recapitalisation plan for the PSBs amounting to approximately 1.3 per cent of GDP, as well as the establishment of a mechanism to seek consolidation across these banks, it said.