RBI warns of lagged impact of slowdown on bank profits .

Mumbai, March 25 The Reserve Bank of India on Thursday cautioned that the economic slowdown could have a lagged effect on the credit quality and profitability of banks.

Despite a relatively strong outlook, the RBI, in its maiden Financial Stability Report said, it was clear that the economic slowdown had decelerated growth in the balance sheet of the banking system.

The very rapid credit growth prior to the onset of the current (global financial) crisis and the subsequent downturn have put some pressure on the asset quality. “The asset quality may also come under pressure in case there are significant slippages in some restructured accounts….. The possibility of a significant increase in the slippage ratio in FY 2010 can, therefore, not be ruled out,” said the central bank report.

As a one-time measure, the RBI, in FY2009, had allowed banks to restructure accounts. These accounts in the standard category constituted 3.1 per cent of the gross advances as at December-end 2009.

NIMs and Profitability

Given the inflationary spiral and the large fiscal borrowing programme, there are likely to be pressures on yields, which in turn may have some impact on banks' cost of funds. Further, banks may also need to make provisions towards depreciation in value of investments depending on the duration of their portfolio. This, according to the RBI, may impact banks' net interest margins (NIMs) and their profitability.

“The margins may also face pressure from the regulatory requirement for increased provisions and calculation of interest on savings bank deposits on a daily basis from April 1, 2010,” the report said.

Margins could be squeezed in view of the current environment of heightened competition and increasing disintermediation. Hence, the report emphasised that there was a need for banks to diversify towards other income sources, which have been stagnant in the past few years. Reliance on bulk deposits, which are typically more volatile than retail deposits and also entail higher cost, have implications for the profitability of banks, their liquidity and asset-liability management, warned the central bank.

“One of the factors we look at is the proportion of core deposits to the total liabilities and to what extent banks rely on wholesale funding sources rather than deposit sources. We also look at the composition of banks assets. How much liquid assets do they have? In case they have a stress, to what extent they can pay up their liabilities quickly,” said Ms Shyamala Gopinath, Deputy Governor.

Liquidity Risk

While the resilience of commercial banks to credit and interest rate shocks has improved over time, the liquidity scenario analysis shows some potential risk.

An analysis of liquidity ratio in the report indicates concentration of deposits at the shorter tenure and credit deployment in the medium to long term nature, implying structural mismatches embedded in banks' balance sheets. The RBI also expressed concern that growing infrastructure financing may further widen the existing asset-liability mismatches. The rate of growth of infrastructure funding by banks has been very high and consistently above 30 per cent.

Pointing out that there was increased reliance on wholesale deposits to support balance sheet growth, the report observed that the same needs corrective action.

The banking sector, according to the report, is adequately capitalised, the dominant component being loss absorbing common equity. The comfortable capital adequacy position (the overall capital to risk-weighted assets of commercial banks stood at 14.1 per cent as of December-end 2010) indicates that there is no immediate concern about banks' ability to fund expansion once growth momentum picks up.

Stress tests for credit and market risk indicate that banks are comfortably resilient and even if, in a worst case scenario, it is assumed that all restructured standard advances were to become NPAs, the stress would not be significant.

Source : Business Line