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RBI’s financial stability report is not worry free
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Context
The Reserve Bank of India's (RBI) Financial Stability Report (FSR) for March 2024 presents a mixed picture of the financial sector's health. While it highlights the banking sector's strong performance, there are underlying concerns regarding household savings, foreign direct investment (FDI), and potential risks in asset valuations.
Current State of the Financial Sector:
- Banking Sector Health: The FSR indicates that banks' balance sheets are improving, with lower non-performing asset (NPA) ratios, higher provisioning, stronger capital positions, and robust earnings, leading to sustained credit expansion.
- Economic Resilience: The report suggests that the Indian economy is poised for resilient growth, supported by macroeconomic and financial stability.
- Sector Focus: Given the dominance of banks in the Indian financial system, the FSR focuses primarily on the banking sector as crucial for overall financial stability.
Concerns Highlighted in the FSR:
- Decline in Savings Rate: There is a notable decline in the gross savings rate to 29.7% of gross net disposable income, with household savings falling from 20% during 2013-22 to 18.4% in 2022-23.
- Shift in Savings Composition: The share of net financial savings in total household savings has decreased from an average of 39.8% during 2013-2022 to 28.5% in 2022-23, with net financial savings falling to 5.3% of GDP in 2022-23.
- Drop in FDI: Foreign direct investment has significantly declined from $28 billion in 2022-23 to $9.8 billion in 2023-24, while foreign portfolio investment (FPI) increased from minus $4.8 billion to $44.6 billion in the same period.
Risks and Policy Implications:
- Asset Valuation Risks: The FSR warns of potentially stretched asset valuations, with the latest monetary tightening associated with rising prices of riskier assets, contrary to the usual risk-off sentiment.
- Non-Bank Financial Intermediation: The growing role of non-bank institutions in financial intermediation and hidden leverage could amplify stress in the face of large shocks, spreading contagiously across financial market segments.
- Need for Vigilance: The fine print of the FSR suggests that the apparent stability might conceal underlying vulnerabilities, necessitating closer scrutiny and potential policy actions to address emerging risks.
UPSC Mains Questions:
Q. Discuss the risks associated with asset valuations and non-bank financial intermediation as highlighted in the RBI’s Financial Stability Report. What measures can be taken to mitigate these risks and ensure financial stability?
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