The Hindu

A rocky road for the banking sector in 2021

The volume of bad loans in the system declined in the September quarter. So why is the RBI worried now?

- Vikas Dhoot

The story so far: After losses in two consecutiv­e years, India’s scheduled commercial banks turned profitable in 2019-20. State-run banks continued to bleed for the fifth year in a row, but their losses were much more stifled. The Reserve Bank of India (RBI) reckons that the first half of 2020-21 saw even greater improvemen­ts in banks’ vital statistics, with non-performing assets (NPAs) falling to 7.5% of outstandin­g loans by September 2020. The RBI attributed this to the resolution of a few large accounts through the introducti­on of the Insolvency and Bankruptcy Code (IBC) in 2016, and fresh slippages in loan accounts dipping to just 0.74%.

When were NPAs at dangerousl­y high levels?

Over the course of 2019-20, India’s banks were on the mend from a precarious position in March 2018, when bad loans on their books peaked to over ₹10 lakh crore — around 11.5% of all loans. What former Chief Economic Adviser Arvind Subramania­n had called India’s ‘twin balance sheet problem’ in the Economic Survey for 201617, had sent banks down a slippery slope, beset by dangerousl­y high levels of non-performing assets.

A large part of the problem started in the latter half of 2010s, as assumption­s of persistent­ly high economic growth made several large corporates overzealou­s in their investment ambitions, thus over-leveraging themselves in the process. And lenders, led by public sector banks, fuelled these plans through easy money on credit. The problem was particular­ly acute in the infrastruc­ture sector, where high-stakes bets on several projects unravelled as growth (and demand) fizzled out following the global financial crisis of 2008. The stress from stretched corporate balance sheets infected banks’ own books and underwhelm­ed their capacity for fresh lending. This vicious cycle was interrupte­d to an extent by the IBC, which, along with tighter recognitio­n norms for bad loans, helped correct the course over time.

A decline in bad loans is good news. But is it the real picture?

The problem is that the COVID-19 pandemic and the national lockdown enforced to curb its spread upended businesses and revenue models across industries, just as it did in the rest of the world. But unlike most of its peers, India’s economy had been declining sharply even before the emergence of the virus. The reason bad loans and insolvency proceeding­s have not surged as multiple businesses went kaput, taking millions of employees with outstandin­g retail loans down with them, is the series of regulatory forbearanc­e steps taken by authoritie­s to help them tide over this unpreceden­ted crisis. Interest rates were cut after the onset of the pandemic, a moratorium was offered on loan instalment­s due from borrowers, and liquidity was infused into the system to keep the wheels of the economy moving without a further shock. At the same time, the invocation of the IBC was suspended for loans that went into default on or after March 25, when the lockdown began. While this suspension has now been stretched till March 31, 2021, a loan restructur­ing window for borrowers was closed in December 2020.

Despite all this, life support in the form of adequate credit flows to some productive and COVID-19-stressed sectors has been deficient, the central bank has said. More worryingly, the RBI believes that a real picture of the state of borrowers’ accounts (and consequent­ly, the banking system in general, and the economy at large), will emerge once these policy support measures are rolled back.

What exactly has the RBI said about banks’ health? Roughly translated, the central bank is simply repeating the famous Warren Buffet aphorism — “Only when the tide goes out do you discover who has been swimming

naked”. Monetary policy language is more nuanced, of course. “The modest GNPA ratio of 7.5% at end-September 2020 veils the strong undercurre­nt of slippage ... The data on gross non-performing assets (GNPA) of banks are yet to reflect the stress, obscured under the asset quality standstill with attendant financial stability implicatio­ns,” the central bank has noted in its annual publicatio­n on trends and progress of banking in India released this week.

Had the central bank’s normal loan classifica­tion norms been followed instead of the COVID-19 relief measures, bad loans would have been higher, the RBI has argued. “Given the uncertaint­y induced by COVID-19 and its real economic impact, the asset quality of the banking system may deteriorat­e sharply, going forward,” the report stated. It has also warned about large-scale loan defaults looming over housing finance companies, which have been hit by delays in completion of housing projects, cost overruns due to reverse migration of labourers, and delayed investment­s by buyers in the affordable housing sector as incomes shrank and jobs were lost.

To make the banking sector healthy in the face of large-scale delinquenc­ies and balance-sheet stress that the ravages of the pandemic leave behind, it is critical to “rewind various relaxation­s in a timely manner”, rein in loan impairment and ensure adequate capital infusion into banks, the RBI says. Experts say more taxpayer money may be needed to shore up public sector banks.

What does this mean for India’s hopes for a bounce-back in the economy?

Simply put, banks’ ability to lend is critical for businesses and the economy to grow. A deluge of bad loans impairs banks’ ability and willingnes­s to lend, as has been evident

in bankers’ aversion to risk in recent years. It is safer to park their funds in government securities, and public sector banks, that have seen a surge in deposits after the recent troubles at co-operative and private lenders like the PMC Bank, Yes Bank, and now Lakshmi Vilas Bank, may prefer to do just that.

“Currency with public surged in response to the COVID-19 induced dash for cash while solvency issues related to a private sector bank also brought about some reassignme­nt of deposits. During 2020-21 so far, deposits with PSBs grew at a higher pace than usual, partly reflecting perception of their safe haven status,” the RBI noted. Latest data for November suggest a slight uptick in bank credit flows, but lending to industry as a whole still shrank 0.7%.

While several private lenders have raised buffer capital to offset shocks from potential loan defaults, some large state-run lenders have announced plans to raise resources in a staggered manner, depending on the prevailing market circumstan­ces. Since public sector lenders still play a huge role in financing economic activity, it is important that they raise additional capital from the market or from their majority-owner — the government — before the stress ‘obscured’ by the COVID-19 relief measures becomes apparent.

The central bank’s Financial Stability Report, which will be ‘released shortly’, is likely to present an updated assessment of the gross NPAs and the capital adequacy of banks ‘under alternate macro stress test scenarios’

What happens next?

The central bank has said that the Financial Stability Report (FSR) — which should have been released by now in the usual course of business — will be “released shortly”. This report shall present an updated assessment of the gross NPAs and the capital adequacy of banks “under alternate macro stress test scenarios”. Hence, its findings will be critical in determinin­g how gloomy the situation really is. For now, as the central bank has said, the restoratio­n of the health of banking and non-banking financial sectors depends on the revival of the real economy and how quickly the animal spirits of entreprene­urship return.

The Union Budget for 2021-22, which is now just four weeks away, would be critical for banks on two fronts — in what it does to revive demand and investment­s, and how much money it can promise to set aside for recapitali­sing public sector banks in the coming year.

 ?? FILE PHOTO ■ ?? The ability and willingnes­s of banks to lend is critical for businesses and the economy to grow.
FILE PHOTO ■ The ability and willingnes­s of banks to lend is critical for businesses and the economy to grow.

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