IMF Report on India's Financial System

IMF Report on India's Financial System

Why in News?

The International Monetary Fund (IMF) has raised concerns about stress in Non-Banking Financial Companies (NBFCs) in its report, India Financial System Stability Assessment. The report highlights the potential risks this poses to India's financial system.

Key Highlights of the IMF Report on India's Financial System:

• NBFC Stress and Systemic Risk:

  • 63% of power sector loans in FY 2024 were provided by the three largest Infrastructure Financing NBFCs, an increase from 55% in 2019-20.
  • 56% of NBFC lending is financed through market instruments (mutual funds and corporate bond markets), with the rest coming from bank borrowings.
  • State-owned NBFCs like the Indian Renewable Energy Development Agency (IREDA) are at higher risk due to their significant exposure to the power sector, which faces financial delays and stress. Without expected revenue inflows, NBFCs face asset-liability mismatches that impede repayment.
  • Unlike banks, NBFCs cannot accept demand deposits, lack deposit insurance, and do not have direct access to liquidity from the Reserve Bank of India (RBI), making them more vulnerable to financial strain.

• Stagflation Risk and Impact on PSBs:

  • The report warns that geopolitical risks and poorly calibrated monetary policies from major central banks could lead to rising interest rates and slower economic growth, impacting both NBFCs and banks.
  • IMF stress tests suggest that Public Sector Banks (PSBs) could struggle to maintain the 9% Capital Adequacy Ratio (CAR) in the event of stagflation (a combination of slow growth and high inflation).
  • The RBI requires PSBs to maintain a 12% CAR and 9% for scheduled commercial banks.

• Financial Inclusion Growth:

  • Nearly 80% of Indian adults now have financial accounts, aided by a wide-reaching banking network and digital tools like the Unified Payments Interface (UPI).
  • The surge in retail investors has turned India into one of the largest equity options markets globally.

• Financial System Assets:

  • The assets of India's financial system, which include banks, NBFCs, insurance companies, mutual funds, and pension funds, amount to nearly 190% of the country’s GDP. Of this, banks hold 60% of the total financial assets.

• Recommendations for Financial Stability:

  • The IMF recommends that PSBs should retain earnings, rather than paying dividends to the government, to strengthen their capital reserves and support economic recovery during downturns.
  • Improved data sharing on NBFC credit and exposures is essential to better assess risks.
  • The IMF suggests that state-owned NBFCs should be subject to the same regulatory requirements as private sector NBFCs to ensure a level playing field.
  • It also advises prioritizing financial stability over aggressive lending aimed at economic development.

Drishti Mains Question:
How does the high exposure of NBFCs to the power and infrastructure sectors pose financial risks? Suggest regulatory measures to mitigate these risks.

UPSC Civil Services Examination, Previous Year Question (PYQ):

Prelims: Q1. "Rapid Financing Instrument" and "Rapid Credit Facility" are related to the provisions of lending by which one of the following? (2022)
(a) Asian Development Bank
(b) International Monetary Fund
(c) United Nations Environment Programme Finance Initiative
(d) World Bank

Ans: (b)

Q2. "Gold Tranche" (Reserve Tranche) refers to (2020)
(a) A loan system of the World Bank
(b) One of the operations of a Central Bank
(c) A credit system granted by WTO to its members
(d) A credit system granted by IMF to its members

Ans: (d)

Q3. "Global Financial Stability Report" is prepared by the (2016)
(a) European Central Bank
(b) International Monetary Fund
(c) International Bank for Reconstruction and Development
(d) Organization for Economic Cooperation and Development

Ans: (b)

Mains:
Q. The World Bank and the IMF, collectively known as the Bretton Woods Institutions, are the two inter-governmental pillars supporting the structure of the world’s economic and financial order. Superficially, the World Bank and the IMF exhibit many common characteristics, yet their roles, functions, and mandates are distinctly different. Elucidate. (2013)

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