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Outlook of Indian financial sector: Fitch Ratings

Fitch Ratings in its special report 'The Indian Banking System', states that the economic reforms initiated by the Indian government in the early nineties have considerably improved the health and the outlook of the country’s financial sector.

Reforms had led to greater operational autonomy for the PSBs, entry of new participants in the banking, insurance and mutual funds, and creation of new institutions for trading, clearing and settlements, which, in turn, resulted in greater depths for domestic debt market and encouraged private participation in the derivatives and forex markets.

According to the Fitch's report, improved credit standards, an increased focus on recoveries and the enactment of Securitisation And Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI) are among the reforms that will help Indian banks. the reforms have led to greater operational autonomy for public sector banks, application and a gradual tightening of capital adequacy, asset classification and income recognition, as well as increased disclosure levels.

Moreover, systemic support to banks, in the form of re-capitalisation of public sector banks in the 1990s, or the merger of weak commercial banks with larger public sector banks, has been repeatedly demonstrated. The pattern of support extended by the government to troubled banks and financial institutions highlights an emphasis on ensuring repayment of retail and foreign liabilities first.

The benign interest rates had helped the banks to up their profits from trading in Government securities and these gains were used by banks for writing off large amounts of non-performing assets (NPAs).

According to report, the reported net non-performing loans (NPLs) of Indian banks has improved over the years. Although the effective NPL level, adjusted for internationally comparable norms (Indian banks will move to the 90-day norm for NPL classification from March 2004, could be double the reported figure of 4.5 per cent as at end-March 2003, the industry is well placed to address such key issues.

Fitch believes that the Reserve Bank of India (RBI) has helped maintain the stability of the Indian banking system through “prompt corrective actions”. It is now migrating to a risk-based supervision system, and is charting a roadmap for transition to the new Basel Capital Accord by March 2007. RBI has played a supportive role to maintain confidence in the banking system without providing any guarantee to support banks, says Fitch.

However, Fitch warns that weakening DFIs (development financial institutions), vulnerable non-banking finance companies and the inadequately supervised cooperative banks "pose risks" to the financial system.

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