The suspension of fresh insolvency proceedings for a period of one year under IBC comes as a breather for MSMEs, but could lead to steep haircuts for banks
The stimulus package, the size of which is open to dispute (perhaps closer to ₹2 lakh crore in terms of fiscal relief than ₹20 lakh crore), comes with a hidden cost for the already fragile banking sector — with the Centre relying largely on delivery of credit to boost the economy. A dilapidated economic landscape not only implies persistent weakness in credit offtake but also throws up the risk of a wave of insolvencies hitting businesses and individuals. Banks, which are already grappling with the actual impact of the three-month moratorium (30-40 per cent of loans), are now staring at a sharp rise in delinquencies in the months ahead as insolvencies spike. Had the fiscal package contained demand side measures that helped individuals and businesses tide over interrupted incomes and revenues, it would have helped cushion the impact of the moratoriums and recession on bank balance sheets. But the package, mainly comprising loans and liquidity measures, does nothing to help mitigate these risks.
With higher balance sheet risks looming on the horizon, the effectiveness of RBI’s ₹8 lakh crore liquidity measures may also be under a cloud, given banks’ aversion to risky lending. The ₹3 lakh crore worth of collateral-free loans for MSMEs is aimed at breaking the credit logjam, the logic being that banks may extend credit, thanks to the guarantee (government as guarantor in case of default) and zero risk-weight (lower capital strain). But the scheme covers only good borrowers (less than 30 days past dues). Here too, according to SIDBI’s draft scheme, the emergency working capital funding would be limited to 15 per cent of working capital for loans up to ₹1 crore and to 10 per cent for loans between ₹1-25 crore. While the limit can be extended to cover six months’ salary outgo, the need could be higher in sectors where other costs are significant. While the sovereign guarantee addresses the risk aversion to a large extent, given the past experience with claim approvals and delays in recovery of dues under subvention schemes, banks may continue to deploy funds selectively. These processes need to be fine-tuned for the measures to work.
The suspension of fresh insolvency proceedings for a period of one year under IBC comes as a breather for MSMEs, but could lead to steep haircuts for banks, as the value of their underlying assets erodes. The RBI and the Centre may have to step in to address the systemic risks of banks increasing provisions and running short of capital amid the pandemic crisis. Extension of moratorium and one-time restructuring have become critical to keep asset quality risks at bay. The Centre will also have to ensure substantial recapitalisation of PSU banks — frontloading the capital if need be — to offer a sufficient buffer to absorb losses and meet the credit needs of a battered economy.