Financial Stability Report – Burning Issues – Free PDF Download


What has happened?

  • Last week, the Reserve Bank of India (RBI) released its latest Financial Stability Report (FSR).
  • As the name suggests, it details the state of financial stability in the country, and it is prepared after taking into account the contributions from all financial sector regulators.
  • In other words, it details the current status of different financial institutions such as all the different types of banks and non-banking lending institutions.
  • It also maps the state of credit growth and the rate at which borrowers are defaulting on paying back loans.

  • To arrive at these conclusions, the RBI looks at the state of both the global as well as domestic
  • It also conducts certain “tests” to figure out how different variables may be affected if the economy does not grow as anticipated.
  • The RBI also conducts a Systemic Risk Survey (SRS), wherein it asks experts and market participants to assess the financial system on five different types of risks — global, financial, macroeconomic, institutional and general.
  • Reading the FSR tells us how robust or vulnerable our financial system — especially our banking system — is to the changes in the economy.

What is FSDC?

  • First mooted by the Raghuram Rajan Committee in 2008.

  • Finally in 2010, the then Finance Minister, Pranab Mukherjee, decided to set up such an autonomous body dealing with-
  • Macro prudential and financial regularities

Global growth to falter

  • “Since the July 2021 issue of the FSR, the rejuvenation of the global recovery in the first half of 2021 has started losing momentum,
  • Impacted by resurgence of infections in several parts of the world, supply disruptions and bottlenecks and the persistent inflationary pressures that have manifested themselves in their wake,” states the latest FSR.
  • “The slowdown in activity is occurring even in countries with relatively high vaccination rates that seemed to be emerging as global growth drivers.”
  • The Goods Trade Barometer of the World Trade Organization (WTO) shows that the World merchandise trade volumes, which had risen 22.4% year-on-year in Q2 (April to June) of the 2021 calendar year, have been slowing in the second half of the year.
  • Another key index is the Baltic Dry Index, which is a measure of shipping charges for dry bulk commodities. This index crossed its highest mark in more than a decade in October 2021, but it recorded a sudden drop after that.

  • What has complicated matters more is the rise of the Omicron variant.
  • All this has a considerable impact on even the emerging economies (such as India) where vaccination rates are even lower than advanced economies and which are also likely to suffer from central banks in developed countries making money costlier (by raising interest rates).

Real economy vs equity market

  • “Lifted by the bull run in equity markets across the globe, the Indian equity market surged on strong rallies with intermittent corrections,” states the FSR.
  • “Strong investor interest has driven up price-earnings (P/E) ratios substantially.”
  • “This reflects some disconnect between the real economy and equity markets,” the RBI report.

Bank credit growth

  • According to the FSR, the banking stability indicator (BSI), which indicates the changes in underlying conditions and risk factors of India’s commercial banks, showed improvement in “soundness, asset quality, liquidity and profitability” parameters when compared to the situation in March 2021.
  • Only in the “efficiency” parameter did this indicator worsen. This is good news since this period includes the disruption due to the vicious second wave of Covid-19.

NPA may rise

  • A key variable to watch out for in any FSR is the state of bank NPAs.
  • In particular, each FSR conducts some “stress tests” to find what will happen to the NPA level if things go wrong.
  • These stress tests are nothing but “hypothetical adverse economic conditions” and are done by taking progressively worse values of variables such as GDP growth, combined fiscal deficit-to-GDP ratio, CPI inflation, weighted average lending rate, exports-to-GDP ratio and current account balance-to- GDP ratio.
  • The latest FSR pegs the NPA of India’s Scheduled Commercial Banks (SCBs) at 6.9% at end-September 2021.
  • “Stress tests indicate that the Gross NPA ratio of all SCBs may increase to 8.1% by September 2022 under the baseline scenario and further to 9.5% under severe stress,” states the FSR.
  • Among all the banks typically it is public sector banks that are more guilty of such slippages. That stays true this time too.

Systemic risks

  • There are five levels of risks — very high, high, medium, low and very low.
  • On the whole, the Systemic Risk Survey (SRS), “across all broad categories of risks to the financial system – global; macroeconomic; financial market; institutional; and general – were perceived as ‘medium’ in magnitude,
  • But risks arising on account of global and financial markets were rated higher than the rest”.
  • For India, the main sources of risks are commodity prices, domestic inflation, equity price volatility, asset quality deterioration, credit growth and cyber disruptions.

Banking prospects

  • There is considerable improvement in the sentiment among respondents when asked about the prospects of banking in the year ahead.
  • In the previous round (Yellow bar), most believed prospects would worsen. In the latest round (Purple bar), however, most expect prospects to improve.

Q) Arrange the following in the decreasing order of the liquidity?

  1. Demand deposits with the banks
  2. Time deposits with the banks
  3. Savings deposits with the banks
  4. Currency
  1. 4-1-2-3
  2. 4-1-3-2
  3. 4-3-1-2
  4. 4-3-2-1




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