A decline in bad loans is good news. But is it the real picture? What exactly has the RBI said about banks’ health?
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 2016-17, 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.
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.