Bad loans: Why, this time, it’s different

Non-performing assets (NPA) or bad loans of banks have come down to their lowest levels, Reserve Bank of India (RBI) governor Shaktikanta Das said at a Confederation of Indian Industry event on March 21. When seen in the context of gross NPA share falling to 6.9% of all loans, according to RBI’s Financial Stability Report released in December 2021 — the latest number is 6.5% — the comments are not surprising. The fall in NPA ratio is accompanied by an improvement in capital adequacy of banks and interest coverage ratio of companies. Deterioration in these two factors led to the twin balance sheet (TBS) crisis in India’s financial system in the last decade.

To be sure, bad loans could see a marginal rise due to stress among small borrowers when the moratorium announced during the pandemic comes to an end later this year. However, most analysts agree that the rise will not be significant. Also, some of the bad loans have been written off, the cost being borne by the exchequer.

What does this development mean for the Indian economy at large? It is good news as far as financial sector stability is concerned. The TBS crisis was an important headwind to India’s growth prospects in the last decade. The growth challenge, at the moment, is different in nature though. It is lack of demand rather than past baggage of bad loans that is holding back investment and demand for credit. For this to change, improvement in mass incomes will matter more than the state of bank and corporate balance sheets. Persistence of inflation due to the ongoing geopolitical disruptions is bound to increase the squeeze on purchasing powers at large. This underlines the importance of continued policy vigilance.