India Needs To Ensure Financial Stability, Inclusion Balance: Report

Basel/New Delhi: India needs to do additional work for having a comprehensive macroprudential policy framework with "clearer boundaries" for various authorities including RBI, while ensuring a balance between financial stability and inclusion, global body FSB said today.  While observing that "important steps" have been taken in recent years to develop the country's macroprudential policy framework, FSB said the

authorities also need to consider potential policy trade-offs in the future. According to the Financial Stability Board (FSB) additional work is needed to flesh out and operationalise a comprehensive macroprudential policy framework.

"Much of this work relates to making macroprudential policy-setting more explicit, with clearer boundaries between authorities and with other policies, as well as in balancing the objectives of promoting financial development and inclusion," its peer review report of India said. 

FSB, which brings together entities from 24 countries and jurisdictions, works towards promoting effective regulatory, supervisory and other financial sector policies in the interest of financial stability. 

India is represented by RBI, Sebi and the Finance Ministry at FSB. 

The report said it would be useful for RBI's systemic risk analysis to become more policy-oriented so that it can support decision-making for macroprudential purposes. 

Having a standardised set of indicators for assessment of risks could also be used by the FSDC (Financial Stability and Development Council) to discuss systemic risks and policy responses. 

While it is understandable that financial development and inclusion are key policy objectives, FSB said they could in principle occasionally come into conflict with maintaining financial stability. 

"The authorities report that, in practice, there has been no conflict thus far and that they view a deeper financial system as contributing to increased financial stability... It is therefore important for the authorities - as they flesh out their macroprudential framework - to consider potential policy trade-offs in the future," FSB said. 

Citing IMF report released earlier this year, FSB said India experienced high credit growth of around 25 per cent per year between 2005-06 and 2010-11, but no aggregate countercyclical macroprudential measures, other than sector-specific tools for commercial real estate and residential housing loans were applied. 

At present, RBI carries out banking system stress tests mainly applying scenarios directly to banks' balance sheets and the same could be enhanced in various ways, FSB said. 

"Models could be further developed to assess the impact of adverse macro scenarios on banks' borrowers, especially those most at risk, and then, in turn, how a deterioration in their balance sheets would feed back to banks' own balance sheets. 

"At present, such adverse scenarios could be applied to highly indebted corporates and include their foreign currency maturity mismatches," it added. 

Further, FSB said authorities should continue to develop techniques that assess financial stability risks outside the banking sector, including linkages between banks and other financial institutions and markets and the impact of external shocks on capital flows. 

According to FSB, it would be useful to continue increasing the coverage and consistency of data on corporate balance sheets. 

The peer review focused on macroprudential policy framework as well as the regulation and supervision of non-banking finance companies (NBFCs) and housing finance companies (HFCs). 

RBI has expanded the use of analytical techniques and stress tests to gauge systemic risks while progress has also been made in addressing data gaps, FSB said. 

Noting that progress has also been made with regard to NBFCs, the report said concerns about the risks from unregulated financial entities and unauthorised financial activities have strengthened the coordination of efforts by the authorities to survey the regulatory perimeter. 

Even though it is typically small, problems in the NBFC sector can become systemic due to interconnectedness with thebanking sector as well as due to their social and political ramifications, the report noted. 

"Going forward, the analysis of potential risks stemming from the ownership structure and interconnectedness of NBFCs and HFCs should be included in both ongoing supervision and in risk assessments," FSB said.