Risks to Indian banks’ capital adequacy have increased in the recent round of stress tests by the Reserve Bank of India with capital levels showing severe deterioration under intense stress. In the Financial Stability Report released on Monday, the RBI said that it remains concerned over the weakening asset quality and soundness of banks.
The report said close ties between lenders would leave the banking system especially vulnerable to contagion in case of trouble at a single institution.
While the Banking Stability Indicator showed that risks to the sector have not changed much since June, banks are vulnerable more than before from risks to capital and profitability due to rising bad loans.
“The factors contributing towards increase in risk, in the order of their share, are liquidity, profitability, soundness and asset quality,” said the RBI.
Stress tests showed that public sector banks would fail to maintain required capital if gross non-performing assets increase sharply. Further, some banks also showed marked weakness in credit concentration stress.
“Stress tests on the credit concentration risk of banks show that the impact under various stress scenarios was significant for six banks, which account for 8% of the assets, with their CRAR falling below 9%,” the RBI said. If the top borrower defaults, the capital loss is estimated to be around 9%.
In addition to these risks to capital, the RBI has warned that PSBs could find it difficult to raise the required buffer capital to meet Basel-III norms going ahead. The central bank notes that banks’ capital adequacy ratio was at a satisfactory 12.8% as of September end.
With insurance companies the only investors in hybrid Tier-I bonds and low valuations in the equity market, PSBs would face challenges in raising more capital, the RBI said. The stress tests assumed three scenarios, including a baseline scenario of 5.5% GDP growth, 7.4% retail inflation rate and 12.1% weighted average lending rate, to gauge the impact on banks.