"Banking sector risks have increased since December 2013, as shown by the Banking Stability Indicator. Though there was a marginal improvement in asset quality, concerns remain about the liquidity and profitability aspects. Stress tests indicate higher vulnerability for public sector banks as compared to their private sector counterparts," the RBI said in its ninth Financial Stability Report.
However, the RBI said further significant deterioration was unlikely under normal conditions.
The report noted that the marginal improvement was due to sales of non-performing assets and an overall improvement in asset quality by banks during the March quarter.
It said stress on the system has increased mainly due to liquidity and profitability pressures. The decline in the growth rate of credit and risk-weighted assets of banks, coupled with a decrease in Tier-1 leverage ratios, indicates efforts at repairing balance sheets have been rewarding.
The half-yearly report said various banking stability measures, based on co-movements in bank equity prices, indicate that distress dependencies within the banking system, which were rising during H2 of 2013, have remained at the same level since January 2014 mainly due to improved sentiments in stock prices.
The stress tests indicate the need for a higher level of provisioning to meet the expected losses of banks under adverse macroeconomic conditions.
On performance of banks and their resilience based on macro stress tests, the report said risks to the system as of March 2014 have increased since the publication of the previous report in December, as reflected by the banking stability indicator, which combines the impact on certain major risk dimensions. Though there are marginal improvements in the soundness and asset quality, concerns over liquidity and profitability continue.