Context: The RBI’s Financial Stability Report released in December 2024, highlights significant improvements in the asset quality of Scheduled Commercial Banks (SCB), with Gross NPA ratios at a 12-year low.
It shows the resilience of India’s financial system, supported by strong capital buffers, improved provisioning and healthy domestic financial fundamentals amidst global uncertainties.
Relevance of the Topic: Prelims: Important Banking-related terms.
RBI’s Financial Stability Report
- Published bi-annually by the Reserve Bank of India.
- It reflects the collective assessment of the Sub-Committee of Financial Stability and Development Council (FSDC), which is headed by the RBI Governor.
- The report evaluates the resilience of the Indian financial system and identifies risks to financial stability.
Important Banking-related Terms
1. Asset Quality Ratio:
- Asset quality ratio (AQR) is a key indicator that measures the proportion of non-performing assets (NPAs) to total assets in a bank.
- A high AQR indicates that a bank has a large amount of bad assets that are dragging down its performance and posing a risk to its solvency.
- A low AQR indicates that a bank has a healthy portfolio of assets that are generating income and interest for the bank, enhancing its profitability and stability.
2. Provisioning Coverage Ratio (PCR):
- PCR provides insights into the adequacy of provisions made by banks to cover potential losses on their loan portfolios.
- It is calculated by dividing the total provisions held by a bank by its total non-performing loans (NPLs).
- It represents the percentage of NPLs that are covered by provisions.
- A higher ratio indicates a stronger ability to absorb potential losses.
3. Capital Adequacy Ratio (CAR):
- CAR is the ratio of a bank’s capital in relation to its risk weighted assets and current liabilities. This is a measure of a bank’s ability to meet its obligations.
- A high CAR means the bank can absorb losses without diluting capital.
4. CASA Ratio (Current Account Savings Account ratio):
- CASA is the proportion of current account and savings account deposits in the total deposits of the bank.
- A low CASA ratio means the bank relies heavily on costlier wholesale funding, which can hurt its margins.
5. Net Interest Margin (NIM):
- This is the difference between interest earned by a bank on loans and the interest it pays on deposits.
- NIM will be high for banks with higher low-cost deposits or high lending rates.
- Low NIM and high NPA is a bad combination.
6. Return on Assets (RoA):
- It shows how profitable a bank’s assets are in generating revenue.
- A lower RoA means that the bank is not able to utilise assets efficiently.
- Negative RoA implies the bank’s assets are yielding negative returns.
7. Capital Conservation Buffer (CCB):
- CCB is a concept introduced under the international Basel III norms.
- According to Basel III norms, during good times, banks must build up a capital buffer that can be drawn from, when there is stress.
- In India, to adhere to Basel norms, RBI wants all the commercial banks to achieve a minimum total capital of 9 per cent and a capital conservation buffer of 2.5 per cent, with the minimum total capital and CCB adding up to 11.5 per cent.
Major Highlights of RBI’s Financial Stability Report
- Gross NPA ratio has declined to a 12-year low of 2.6% in September 2024.
- Scheduled Commercial Bank’s Net NPA ratio stayed at 0.6%.
- Provisioning Coverage Ratio improved to 77% in September, mainly due to proactive provisioning by Public Sector Banks.
- Improvement in Return on Assets and earnings before provisions and taxes.
- Sequential decline in the net interest margin abetted by shift of deposits to higher interest rate buckets.
- Decline in share of low-cost Current Account Savings Account (CASA) deposits.
- Increase in share of term deposits, especially for higher interest-rate buckets.
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