The International Monetary Fund (IMF) has released the “India Financial System Stability Assessment” report.
- The report highlights concerns about stress in Non-Banking Financial Companies (NBFCs) and the potential risks they pose to India’s financial stability.
Key Highlights of the IMF Report
NBFC Stress and Systemic Risk
- Power Sector Exposure:
- 63% of power sector loans in FY 2024 are from the top 3 Infrastructure Financing NBFCs, up from 55% in 2019-20.
- Funding Sources:
- 56% of NBFC lending comes from market instruments (mutual funds, corporate bonds).
- The rest is funded through bank borrowings.
- Vulnerability of State-Owned NBFCs:
- Indian Renewable Energy Development Agency (IREDA) faces risks due to its high exposure to the power sector.
- Issues include delays and financial stress, leading to asset-liability mismatches.
- Financial Limitations:
- NBFCs can’t accept demand deposits, lack deposit insurance, and have no direct access to RBI liquidity, making them prone to financial stress.
Stagflation Risk and Impact on Public Sector Banks (PSBs)
- Geopolitical Risks:
- The IMF warns that rising interest rates due to geopolitical tensions and miscalculated monetary policies by major central banks could slow economic growth.
- Stress Tests for PSBs:
- IMF stress tests suggest PSBs may struggle to maintain the 9% Capital Adequacy Ratio (CAR) during stagflation (slow growth + high inflation).
- CAR Requirements:
- RBI mandates 12% CAR for PSBs and 9% CAR for scheduled commercial banks.
Growth in Financial Inclusion
- Nearly 80% of Indian adults now have financial accounts.
- Growth driven by the expansion of the banking network and digital platforms like Unified Payments Interface (UPI).
- The rise of retail investors has made India one of the largest equity options trading markets
Financial System Assets
- India’s financial system assets (including banks, NBFCs, insurance companies, mutual funds, and pension funds) account for nearly 190% of GDP.
- Banks hold 60% of these financial assets.
Recommendations for Financial Stability
- Capital Retention by PSBs:
- Instead of paying dividends to the government, PSBs should retain earnings to strengthen capital reserves and support economic recovery during downturns.
- Improved Data Sharing:
- Enhance data sharing on NBFC credit and exposures to better assess risks.
- Level Playing Field:
- State-owned NBFCs should face the same regulatory framework as private NBFCs.
- Focus on Stability:
- IMF recommends prioritizing financial stability over aggressive lending for economic growth.
