December 21, 2017

IMF published the Financial System Stability Assessment (FSSA) for India. The report highlights that increased diversification, commercial orientation, and technology-driven inclusion have supported growth in the financial industry, backed by improved legal, regulatory, and supervisory frameworks. Yet, the financial sector is grappling with significant challenges and growth has recently slowed. High nonperforming 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.

The IMF Directors commended the authorities for the major reforms undertaken since the 2011 Financial Sector Assessment Program (FSAP), notably in introducing Basel III standards and risk‑based supervision of banks and securities firms, improving interagency cooperation under the auspices of the Financial Stability and Development Council, and introducing a modern insolvency framework for companies. Stress tests show that while key banks appear resilient, significant vulnerabilities remain. The largest banks appear sufficiently capitalized and profitable to withstand a deterioration in economic conditions, reflecting relatively solid capital buffers and, particularly for the private banks, core profitability that is strong enough to cover credit costs. There is a group of public-sector banks (PSBs) where vulnerabilities seem highest; these banks would require additional capital under the baseline scenario and some would almost deplete capital buffers due to growing NPAs and provisioning needs if stress intensifies.

Directors encouraged the authorities to implement the recommendations of the FSSA to accelerate the resolution of NPAs and the repair of corporate balance sheets. The recently announced measures to recapitalize the PSBs, including through government contributions, will foster consolidation in the sector and support effective resolution of nonperforming assets. Directors welcomed the planned introduction of a special resolution regime for financial institutions, which will improve incentives and reduce the potential risks to public resources that could arise from the failure of financial institutions. They urged the authorities to continue with efforts to further align the proposed resolution framework and other components of the safety net with international standards and best practices. Directors also welcomed the important progress in enhancing the framework for anti-money laundering and combating the financing of terrorism, and called on the authorities to overcome the remaining gaps. Other key highlights of the report are as follows:

  • International Financial Reporting Standards (IFRS) 9. RBI is reviewing loan classification and provisioning rules for implementation of IFRS 9. RBI should also consider a prudential filter as a regulatory floor after the introduction of expected loan loss provisioning (IFRS 9) in April 2018.
  • Insurance Sector. The introduction of risk-based solvency and supervision should be given priority. The Insurance Regulatory and Development Authority of India (IRDAI) needs to formulate and communicate a strategy, a plan, and a timetable for introduction of a risk-based capital adequacy framework. This should initially follow a standardized approach (not internal models), cover all types of risks, and require insurers to develop own risk-and-solvency assessments.
  • Securities Markets. Securities and Exchange Board of India, or SEBI, has made significant efforts to address the recommendations of the previous FSAP. The regulatory and supervisory framework for commodities markets should be unified. Unifying the oversight of all commodities markets would promote more efficient market functioning, in line with the authorities’ intention to modernize the sector.
  • Oversight of Financial Market Infrastructures (FMI). RBI regulation and oversight of the securities and derivatives clearing and settlement systems are broadly effective. The Clearing Corporation of India (CCIL) plays a critical role in all money market segments and acts as a central counterparty (CCP) for the government securities repo and secondary markets. RBI has designated CCIL as a Qualified CCP and has authorized it to offer FMI services to several money market segments. CCIL has a prudent risk management framework and high operational reliability.

 

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Keywords: Asia Pacific, India, Banking, Insurance, Securities, FMI, FSSA, FSAP, NPLs, IFRS 9, IMF

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