The financial sector expanded whilst remaining stable despite challenging market conditions both globally and domestically, and continued to support the growth momentum in the economy. Amidst the expansion, the risk absorption capacity of the financial sector improved with higher capital levels, adequate liquidity buffers and healthy earnings.
Further, the supervisory and regulatory framework was strengthened and banks were directed to manage risks in an integrated manner while the financial safety nets in place also helped build confidence in the financial sector and promote financial system soundness.
The ceiling on credit which was imposed early in the year helped moderate the expansion of credit. As monetary conditions tightened, the net interest margins in the banking sector declined marginally. Nevertheless, profitability of the banking sector has surpassed that of the previous year along with an increase in both interest income and non-interest income.
Moreover, by raising funds abroad, the banking sector diversified its sources of funding, which would further strengthen its balance sheets. During the year, the branch network of banks, finance companies and leasing companies as well as the insurance sector expanded further, increasing access to finance.
Measures were taken requiring banks to open SME centres to ensure greater access to financing for SMEs. The legal and operational framework for microfinance that is expected to come into force would help expand the availability of financing for micro enterprises.
Performance of the insurance sector improved during the year as reflected by the higher gross premia, healthy profitability, and higher solvency margins while the strengthening of the regulatory framework pertaining to insurance companies will help promote financial system soundness.
Although financial markets were volatile during the early part of 2012, the policy measures taken were able to restore stability in financial markets during the latter part of the year. With the tightening of monetary policy to prevent the build-up of demand pressures and the liquidity constraints that prevailed intermittently, there was upward pressure on deposit and lending rates during much of the year. However, the tax adjusted average weighted call money rate has remained within the policy interest rate corridor, despite volatility seen during the first half of the year.
Although there was volatility in exchange rates vis-à-vis the rupee during the early part of the year, the measures taken to reduce imports along with foreign currency inflows have contributed towards stabilising the domestic foreign exchange market and raising the level of international reserves.
Despite continued foreign investor purchases in the stock market, its downward trend continued through much of the year although a limited turnaround was seen during the last quarter of the year.
Continued strengthening of the supervisory and regulatory framework governing the financial sector has ensured that a sound and conducive environment for effective financial intermediation prevails.
In order to further strengthen the risk assessment and capital planning processes of banks and ensure that they are in line with international best practices, the Central Bank issued a Consultation Paper on the supervisory review process, in accordance with Pillar II of Basel II. Financial reporting by financial institutions will improve with the application of the accounting standards introduced in 2012, which are in line with international financial reporting standards.
A panel of external auditors was appointed for finance companies and leasing companies, to ensure that the audits of finance companies and leasing companies meet the required standards. A direction was issued to leasing companies requiring them to strengthen their corporate governance provisions relating to fitness and propriety of directors and the senior management. The payment and settlement system operated with a high degree of availability and safety.
The Central Bank continued its efforts to promote mobile phone based e-payment systems as they provide secure and cost effective means of making small value payments. Measures were also taken to improve contingency planning of the key institutions in the financial system so as to ensure customer protection.
The financial sector is expected to remain stable, underpinned by adequate capital, healthy earnings and an effective regulatory and risk management framework. Further efforts will be directed toward raising efficiency of the financial sector and enhancing financial system stability so as to enable the economy to move to a higher growth path. A series of tax incentives granted is expected to spur the growth of the capital market, in particular the corporate bond market.
The announced measures to further liberalise exchange control regulations permitting corporate entities to borrow abroad with greater ease would accelerate the deepening of the domestic financial system and promote its integration with the global financial system. However, risks arising due to global developments need to be monitored, given their implications for market sentiment and capital flows.
To promote greater harmonisation with international regulatory standards and increase the resilience of the banking sector by enhancing capital in terms of quantity and quality, and raising the level of liquid assets maintained, the Central Bank will take measures to implement Basel III standards on a staggered basis.
The bank will also continue to develop macro-prudential approaches to regulation, which would complement the supervision of individual institutions, to pre-emptively address systemic risks as well as contagion risks to financial system stability and enhance the ability of the financial sector to withstand macroeconomic shocks.