Banks need to closely monitor slippages in restructured assets and non-banking finance companies (NBFCs) need to be wary of rising borrowing costs as financial conditions tighten, according to the Reserve Bank of India.

Referring to banks’ balance sheets remaining resilient in 2021-22 and 2022-23 so far, and more recently witnessing healthy acceleration with broad-based credit growth, the central bank emphasised that going forward, it is imperative that they ensure due diligence and robust credit appraisal to limit credit risk.

“The uncertainties characterising fast-changing macroeconomic scenario amidst formidable global headwinds during 2022-23 can pose new challenges to the banking sector.

“If downside risks materialise, asset quality could be affected. Hence, slippages in restructured assets need to be monitored closely,” per RBI’s Report on Trend and Progress of Banking in India 2021-22.

Timely resolution of stressed assets is essential to prevent asset value depletion, the report said.

Although presently the Indian banking sector remains robust and resilient with improved asset quality and strong capital buffers, RBI observed that the policymakers remain mindful of dynamically evolving macroeconomic conditions that may impinge on the health of regulated entities.

In an environment of rising interest rates, an increase in banks’ net interest income (NII) can be expected in the near term, reflecting better transmission to lending rates, opined the report.

On the other hand, higher yields expose banks to MTM (mark-to-market) losses on their treasury investments, decreasing their non-interest income.

In this regard, RBI underscored that the impact of rising yields on Scheduled Commercial Banks’  (SCBs’) profitability has been mitigated to some extent by the increase in the limit of SLR (statutory liquidity ratio) securities under the held to maturity (HTM) portfolio.

Uncertain outlook

With global growth set to deteriorate in 2022 and with rising prospects of a recession in 2023, credit growth, could procyclically decelerate across major economies which, in turn, could shrink bank profitability, RBI said.

“While banks weathered the pandemic with high capital buffers and improved asset quality, going forward, they face a highly uncertain outlook, with the possibility of continuing geopolitical tensions, tighter monetary and liquidity conditions and potential adverse spillover effects on profitability and asset quality,” the central bank said on global banking developments.

Moreover, wider adoption of technology in the financial system amidst a new wave of innovations and climate change risks pose new challenges for financial stability that would require risk mitigating regulatory and supervisory actions.

RBI said NBFCs need to be mindful of the rising interest rate cycle and persisting uncertainties due to global shocks.

NBFCs also face intensifying competition from banks, particularly in segments that were their strongholds like vehicle and gold loans.

“The fast growing digital lending ecosystem poses novel challenges, and regulated entities need to be cautious about unethical recovery practices and data privacy issues.

“These entities also need to strengthen their oversight of outsourced activities to prevent undue harassment of their customers by third party applications,” RBI said.