A preliminary assessment of the banking sector’s health shows that it is encouraging, but banks and financial institutions are expected to proactively undertake stress testing of their loan books, according to Reserve Bank of India Deputy Governor M Rajeshwar Rao.

Banks must prudently ascertain whether the current asset quality is on account of improvement in business fundamentals, arising from deleveraging and efficiency gains, or due to support from fiscal and monetary authorities, Rao said at IMC’s annual banking and finance conference.

The RBI expects banks and other financial institutions to proactively undertake stress testing of their loan books, subjecting them to various levels of stress, including extreme scenarios to estimate the credit buffers to absorb credit losses and take measures to augment the buffers he added.

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Rao observed that preliminary data show that the asset quality of banks has improved, with gross and net non-performing asset ratios improving  compared to pre-pandemic levels. Capital and loan growth have also improved, he added.

NPA ratios

Gross and net non-performing asset ratios, which were 9.23 per cent and 3.66 per cent, respectively, as at September-end 2019, improved to 5.97 per cent and 1.7 per cent as at March-end 2022.

The Deputy Governor said the effectiveness of any policy response in crisis situations is critically dependent on the strength of the financial sector balance sheets.

In this regard, he emphasised that the Indian banking system remains resilient, with the asset quality improving from the pre-pandemic levels and the banks being well-capitalised.