The stability and sound health of the banking system hence is a key pre-requisite for overall economic development and financial stability.The Non-Performing Assets (NPA) is an important prudential indicator to assess the financial health of the banking sector.In the period immediately following the global financial crisis, when asset quality of banks in most advanced and emerging economies was impaired, the asset quality of Indian banks was largely maintained (RBI, AR, 2011-12).
The stability and sound health of the banking system hence is a key pre-requisite for overall economic development and financial stability.The Non-Performing Assets (NPA) is an important prudential indicator to assess the financial health of the banking sector.
This paper explores the macro-financial linkages and micro-level sources underlying the asset quality deterioration.
In line with the ongoing international intellectual discourse, this paper finds the evidence of procyclicality in the Indian context as reflected in past credit boom-bust episodes as well as economic and interest rate cycles.
A brief recap of data and methodology used in this study is outlined in Section III.
Section IV examines the trends in gross advances and NPAs at the aggregate level and also undertakes an empirical analysis to understand the macro-financial linkages underlying the asset quality phenomenon.
Going forward, asset quality could come under greater strains, given the weakening economic backdrop and global headwinds, impinging on the soundness of banks and macro financial stability.
E230, E3, G21 Key words: GDP, business cycles, prices, credit, assets Preface The Indian banking sector accounts for a major portion of financial intermediation and is considered to be the main channel of monetary policy transmission, credit delivery and payment systems.
In the Indian context also empirical research suggests that asset quality is one of the main determining factors of credit, besides time deposits and lending interest rate (RBI, RCF, 2006-08).
With the initiation of the reform process in the early 1990s, there has been a paradigm shift in the credit allocation process from micromanagement to a greater role for market forces.
Moreover, these problems prey on the weak banks, which are vulnerable and have relatively small amounts of capital to absorb unanticipated losses.
NPAs generate a vicious cycle of effects on the sustainability and growth of the banking system, and if not managed properly could lead to bank failures.