The Reserve Bank of India (RBI) on Friday warned that with high bad loans and inadequate provisioning to cover the same, any relaxation in the regulatory capital requirement or risk-weights could be detrimental to banks in particular and the economy in general.

The Basel III norms recommend risk-weights for various credit exposures, based on cumulative default rates (CDR) and recovery rates observed internationally. However, CDRs and the loss given default (LGD) rates observed here are much higher than international average, RBI said in its annual report on 'Trends & Progress of Banking.'

"Therefore, applying the Basel-specified risk-weights would understate the true riskiness of loan assets carried on the books of our banks," the report warned.

The current levels of provisions maintained by banks may not be enough to cover expected losses, it said and added that adequacy of buffers becomes an important issue to absorb expected losses but not adequately provided for, if and when they materialise.

The report also underlined the need for recognizing that the domestic banking system has a high proportion of un- provided for NPAs vis--vis the capital levels although after IBC and RBI's revised framework for resolution of stressed assets, there have been some improvements in the default and recovery rates.

Further, the report also noted the calls for reducing the regulatory capital requirement from bankers and a section in the finance ministry, which was one of the contentious issues between government and the past governor Urjit Patel and sudden exit from the central bank early this month.

"The case for a recalibration of risk-weights or minimum capital requirements would need to be carefully assessed-frontloading of regulatory relaxations before the structural reforms fully set in and conclusive evidence on sustained improvement in CDRs and LGDs is observed-could be detrimental to the interests of the economy," the central bank said.

The report highlights that capital position of banks has improved and calls FY18 a watershed year in the resolution of stressed assets. On the issues surrounding the NBFC sector, RBI says the inherent strength of NBFCs coupled with RBI vigil will ensure growth is sustained and liquidity fears are allayed.

On specific trends in asset quality of banks, the report said that quarterly data showed a significant decline in fresh slippages across banks during 1HFY19. RBI said the industrial sector contributed three-fourths of total bad loans. The agricultural sector reported an uptick in the gross NPA ratio, possibly reflecting a debt waiver by several states, it said. Bad loans from agriculture rose to 8.6 percent in the year ended March 2018 from 8.3 percent a year ago.

The gems and jewellery sector witnessed a significant rise in gross NPAs in the year ended March 2018 with the unearthing of frauds, according to the central bank. However, sectors such as cement and metals reported a decline in their NPA ratios due to large resolutions under the IBC.

(With inputs from PTI)