The Hindu Business Line : RBI cautions banks on higher market risk

While the credit risk environment is expected to continue to be benign in the near future, it can "turn adverse through a deterioration in the market risk environment" the report said.

Global financial imbalances continue to grow, with the US current account deficit now ruling above 6 per cent of its GDP. There is a risk of currency re-adjustments that could cause heightened volatility in the financial markets through changes in exchange rate and interest rate.

The report said " abrupt and sharp readjustment of currencies and consequent rise in interest rates increases the risk of economy to reversal of capital flows with its attendant implications for the exchange rate and asset prices and banks' balance sheets".

The report has also cautioned that banks may face increased risks on account of their exposure to the asset market. Banks have been extending credit for investment in the asset market.

"There is a risk that rise in interest rates in general could impact the housing prices and expose the balance sheets of the households to interest rate risk. This, in turn, could impact banks' balance sheets through increase in loan losses," the report pointed out.

Likewise, the equity market has also seen a sustained uptrend. Reversal of capital flows could impact the equity market and some of the advances extended for investments in the equity market might turn non-performing.

Some banks also have a direct exposure to the equity market.

However, it added that although decline in asset prices could cause loan and capital losses, they may not make any significant impact to the banks' balance sheets, given their limited exposures to the asset markets.

However, it noted that although disruptions in global financial and commodity markets might have some impact, the main risk to the corporate sector and banks' balance sheet emanate from their domestic operations. In this context, the RBI feels that the near-term outlook continues to be positive.

Net NPAS of banks have now fallen to just 2 per cent of net advances and banks have been able to achieve this by using treasury profits during the last few years.

While credit to agriculture has tended to move upwards, the RBI report says that lending to SMEs has stagnated. "This could possibly be due to the perception of higher levels of risk in the sector," it said, adding that financing the growth of a healthy SME sector is essential for the future sustained growth of the economy.

Pointing out that micro-finance institutions (MFIs) now provide several non-credit services such as capacity building, training and micro insurance, it points out that the "focus of discussion is now expanding beyond the narrow domain of micro-credit to encompass micro-finance."

The central bank underscored the need for a clearer policy framework to cover the non-credit financial services by MFIs.

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