The Booby Trap

Coronavirus lockdown has created multiple landmines in the financial services sector. This is how banks and NBFCs are preparing for life post-coronavirus

Executives at HDFC Bank’s headquarters in Mumbai were in for a surprise when they saw a large number of applications for availing the three-month moratorium announced by the Reserve Bank of India ( RBI) to mitigate the impact of Covid-19. Most of the applications were from retail borrowers, who constitute more than half of the bank’s loan book. A quick survey revealed that most borrowers were taking the moratorium out of caution and not due to financial stress.

Not very far away in Pune, the senior management team of Bajaj Finance, one of the country’s largest nonbanking financial companies ( NBFCs), were working on three likely scenarios – in case the lockdown extends to 21 days, 41 days and 49 days, respectively – to lessen the impact of Covid-19 on its business and formulate a strategy to conserve capital, going forward. The NBFC, which has a large portfolio of consumer durables and auto loans, expects business as usual only by the fourth quarter of 2021/22, especially if the lockdown extends to 49 days, till May 15. “The company will be forced to take a harder view on operational expenses and explore a 12-15 per cent cut against the current 7- 8 per cent,” warned Rajeev Jain, Managing Director of Bajaj Finance, in an investor call earlier this month.

Clearly, the financial services industry, with an asset size of ` 190 lakh crore, is approaching the coronavirus crisis in a clinical way to protect its balance sheet. Banks and NBFCs are conducting extensive in- house data analysis of moratorium seekers, especially in the MSME segment and for unsecured loans, including personal loans and credit cards.“Risk departments are the most active now to build scenarios based on the likely behaviour of various sectors and customer segments,” says Padmaja Chunduru, MD and CEO, Indian Bank. According to a rough study done by Business Today, loans worth over ` 35 lakh crore would be under some sort of direct stress because of Covid-19. However, a number of banking professionals told BT that no loan is actually safe.

“Which industry or sector is not impacted by coronavirus?,” asks Sidharth Rath, Managing Director and CEO, SBM Bank ( India).

So, the immediate focus of banks and NBFCs is to identify vulnerable assets ( loans), build default probabilities, ready a collection machinery, make aggressive provisioning from profits, create liquidity buffers to meet redemptions, conserve capital and explore capital-raising options. State Bank of India (SBI) Chairman

Rajnish Kumar even had an advice for businesses – avoid short-term borrowings. “It is advisable to go for a deeper restructuring because if people borrow for short term and are unable to repay on time, it will spoil their credit history,” Kumar told entrepreneurs during a Zoom meeting.

While the banking sector’s biggest worry is on the asset side ( loans and advances), NBFCs, for the first time, are staring at a two-front war on both liabilities

(funding side) as well as assets. Post the IL& FS debacle, NBFCs, which are one-fifth of the banking sector in terms of assets, faced only liquidity issues, while their assets or loan books remained largely untouched, barring a few exceptions.

NBFCs will now have to build liquidity buffers to prepare for a worst- case scenario of higher delinquencies because of non- salaried customers (at a time when layoffs are increasing by the day) and also keep enough liquidity to meet loan prepayment obligations, especially to commercial paper and debenture holders. In fact, there is unlikely to be a 100 per cent exit from the lockdown, and the business impact would easily last six to nine months.

“We are in an uncharted territory,” says the CEO of a public sector bank. There are no past precedents to refer to and learn from. So clearly, the level of impact would only be known once there is a finality on the reach, the extent of damage and the duration of the Covid-19 impact. The casualty would be the Indian economy, which could take months to get back on track.

“Sitting today it would be very difficult to make a prognosis of the future situation,” adds Krishnan Sitaraman, Senior Director, CRISIL Ratings.

WEAK ASSETS: The Diagnosis and the Prescriptions

According to Sameer Narang, Chief Economist, Bank of Baroda, a large number of micro, small and medium enterprises ( MSMEs) and corporate borrowers are availing moratorium. “It is natural because their revenues have slumped, but they still have fixed expenses to pay,” he says.

A Mumbai-based large public sector bank is pooling in resources to track the past behaviour of moratorium seekers in stressed accounts with less than 90 days of default (also referred to as special mention accounts or SMAs in banking parlance).

“Banks are doing stress tests industry by industry. The impact on the airline or the hospitality sector, for example, will be more severe than retail or FMCG,” says Rath of SBM Bank. Half of the banks retail customers are opting for moratorium.

At present, one-fifth of the banking industry’s assets are parked in the retail space. “Nearly, 60 per cent of our customers in the affordable housing segment have paid their EMIs,” says Ajay Kanwal, MD and CEO, Jana Small Finance Bank.

But the problem could come from the unsecured loan segment, where loans have gone to self- employed

and other classes without any collateral. At present, the outstanding loan in the unsecured bucket is over ` 8 lakh crore.

Banks are also studying possible scenarios over the likely payment behaviour of individuals and corporates post moratorium. There is a tendency of customers to default on a personal loan or a credit card outstanding than a home loan. In addition, this is typically the time when school fees, insurance premiums and tax payments are due, and people will set aside funds. Bankers are also focussing on collection through customer analysis of Covid-impacted geographies, including Maharashtra, Kerala, Uttar Pradesh and Rajasthan. For microfinance institutions ( MFIs), the task is more difficult because their collections are mostly in cash and also door-to- door, which makes it more challenging. “We are readying our staff with a focus on hygiene and social distancing when they go out to meet customers tomorrow,” says an MFI player.

Banks are also reaching out to customers via phone to find out the issues they are facing. Will all be able to pay the fourth instalment after the three-month moratorium?

In a note, Emkay Broking has said the deferment of EMIs disturbs the basic financial discipline of repayments, which will eventually be relatively difficult to normalise. While banks have time and again communicated to customers that this is not a waiver, but only a deferment, some are still not clear about the concept of moratorium.

Banks’ MSME loan portfolio alone is around ` 15 lakh crore. Also, auto loans to gig workers, logistics players and Ola and Uber driver carry a higher risk of default since many have gone back to their home towns, while others are jobless.

Then there are trends that are peculiar to the MSME sector, like delayed payments from large corporates. “Large companies may have to scale down production. Cash flow disruptions will lead to delayed payments to MSMEs, triggering credit defaults and permanent business closures of highly leveraged MSMEs,” says Arun Singh, Chief Economist, Dun & Bradstreet.

Bankers are also evaluating the value of collaterals furnished by MSMEs, which is generally in the nature of loan against property. According to a JM Financial report, MSMEs constitute 10 to 20 per cent of the overall loan book of large private banks, while it is 24 to 50 per cent for smaller banks.

A higher provisioning for most of these affected sectors can also help banks avoid “future shocks”. The RBI has already directed banks to make an additional provisioning of 10 per cent for two quarters for stressed accounts