Underlining the sharp turnaround in the NPA cycle after over four years with the dud assets pile going down to 9.3 percent, the Reserve Bank has said despite the recent setbacks, the nation's financial system "remains stable".
"The financial system remains stable despite some dislocation of late," the RBI said in the bi-annual Financial Stability Report released on Thursday evening.
The regulator, however, recommended extra vigil on non-banking finance companies (NBFCs), and warned that a large shadow bank getting hit can have the same impact to the system as a large bank going down.
"As the banks, especially the state-run ones, are on the mend, the structure of non-banking credit intermediation should focus on developing on more prudent lines," governor Shaktikanta Das said in his foreword to the report.
He also pitched for better coordination between the government and the monetary authority to take care of the troubles on the growth front, and advised state-run banks to get leaner in such a way that they are able to attract private capital and not overly depend on public funds.
However, there is something to cheer on the non performing assets (NPAs) front, which has dominated the banking sector for the past four years, with a sharp decline in the pile of dud assets.
"With the bulk of the legacy NPAs already recognised in the banks' books, the NPA cycle seems to have turned around," the FSR said, adding gross NPAs for the system have declined sharply to 9.3 percent as of March 2019 from 11.2 percent year ago.
Under the baseline scenario, the RBI expects NPAs to improve to 9 percent by March 2020.
The stock of NPAs for state-run banks declined to 12.6 percent and is likely to come down to 12 percent by March 2020, the RBI said.
In what signifies the build up of resilience in the system, the report said there has been a sharp improvement in the provision coverage ratio of all banks to 60.6 percent as of March 2019 from 52.4 percent in September 2018 and 48.3 percent in March 2018.
On NBFCs, the regulator warned against potential stress, and pitched for a tighter regulation of the NBFCs and housing finance companies.
"Solvency contagion losses to the banking system due to an idiosyncratic HFC/NBFC failure show that the failure of largest of these can cause losses comparable to those caused by big banks, underscoring the need for greater surveillance over large HFCs/NBFCs," the central bank said.
With all the five of the potentially errant companies on this front being HFCs, the report marked out the HFCs as an important space to monitor, it noted.
The comments come amid a series of setbacks by NBFCs and housing finance companies since last September when one the largest players in the segment-IL&FS group, which owes close to Rs 1 trillion to the system-went belly up.
It can be noted that a slew of HFCs, including Anil Ambani-run Reliance Capital firms and DHFL, have found the going particularly tough with multiple troubles, including debt downgrades and also forced asset sales as the liquidity dried up or became too costly.
The report said the market has got a "discipline" among NBFCs, wherein better performing ones continue to raise funds while those with asset-liability mismatch and asset quality concerns are subjected to higher borrowing costs.
The report said with the outbreak of these troubles, the reliance on long-term funding has increased among NBFCs, while the same on commercial paper and certificate of deposits has gone down.
The financial market risks continue to be perceived as a "high-risk category" affecting the system, while global risks, and risk perception on macroeconomic conditions as also institutional risks are perceived medium, it said.
The report said mutual funds are the biggest supporters of the financial system courtesy the funds that they provide and hence, any disruption in the MF market has immediate and significant spillovers in the asset markets.
On the recent issues involving fixed maturity plans, where schemes run by at least two asset managers have raised concerns, the RBI underlined the need for a better oversight.
"It is particularly important to tune the oversight infrastructure to specifically contextualise the tradeoffs in the context of the business of a specific firm/fund. This may not completely eliminate the risks but will go a long way in containing the spill overs," the report said.
RBI is reviewing its master direction on frauds and considering additional measures for timely recognition of frauds and enforcement action against violations, it said.
The report also pointed that 204 borrowers who had been reported as fraudulent by one or more banks were not classified as such by other banks having exposure to the same borrower, which makes it go for a fresh review.