The IMF and the World Bank in their financial stability assessment report on India, released in mid-January this year, observed that the country has made remarkable progress in developing a stable financial system.

It also states that the country has developed a regulatory and supervisory regime for banks, insurance and the securities market that is largely in compliance with international standards.

However, the report adds a rider, that despite these, the financial system still faces long-standing impediments and new challenges to stability.

Stability may be HIT

This is more or less reflected in the recently released ‘Financial Stability Report of the Reserve Bank, wherein it states that “while stress tests reveal that the financial system is resilient to shocks currently, deteriorating macroeconomic stability can eventually erode financial stability.”

It is a well-acknowledged fact that the economy is facing a lot of problems for quite some time now.

GDP growth has been slowing, missing the target by a wide margin. And, other macroeconomic indicators, such as fiscal deficit, current account deficit, inflation (particularly retail inflation) and unemployment, have also deteriorated. The measures taken by the authorities have not been yielded the desired results.

Agricultural and industrial production, too, has not been encouraging, and the confidence level in the economy has also not been good enough to attract investments.

The financial system, which is said to mirror the real economy, has been facing the litmus test of whether it can continue to remain stable and provide much-needed relief and support to the economy.

The financial system, which consists broadly of the capital, money, forex, debt, and bullion markets, accounts for a major chunk of the transactions in the economy. However, these markets have experienced volatility of late, thanks to both internal and external factors. The rupee is on a free fall, the Sensex is swinging both ways, and bond market yields have gone up.

Also, the banking system has been facing liquidity, credit, operational, forex, and interest-rate risks.

The challenges before the banking system are many and if it fails to adhere to the regulatory requirements and, at the same time, does not support economic growth, its stability is at risk.

Banks have to necessarily readjust their asset-liability management and minimise their market borrowings, raise both current and savings bank account deposits, and long-term deposits beyond three and five years.

They have to avoid short-term deposits and reduce the maturity mismatch too.

The menace of NPAs (non-performing assets) has to be tackled on a war footing, and bad loans other than those caused by the economic slowdown have to be recovered through sale of assets or through effective and speedy recovery mechanism.

The forex market has been witnessing ups and downs due to uncertainties in the international market and on account of domestic issues as well. The external debt as at end-March 2013 was at $390 billion, a 12.9 per cent rise over the previous year. It is way above the foreign exchange reserves, which stood at $288 billion as of June 21.

The trade deficit in May peaked at $20.1 billion, and the foreign inflows are not adequate to finance the deficit.

The measures to contain gold imports have had some positive effect, but the fall in rupee value has partly offset this.

The stock market has been fluctuating widely, and this has been dictated largely by FIIs. But this can be to a large extent be prevented if market regulators/players introduce some innovations in the market.

To counter the dominance and influence of FIIs, the participation of retail and NRI investors needs to be considerably improved by increasing their quota. Similarly, the bond market also needs to be deepened by marketing infrastructure development bonds by major undertakings with government guarantees. The takeout finance concept needs better marketing and encouragement.

The need of the hour is to strengthen the economy with a strong financial system. The blame game between the RBI and the Government for the failure of the economy to perform should end and, instead, they should work together to turn the economy into a fast performing one keeping the financial system stable, strong and healthy.

(The author is a Bangalore-based financial consultant. The views are personal.)

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