Synopsis–Gross retail NPAs have steadily been on the rise and with FY21 numbers breaching the five-year average by a huge margin, regulatory forbearance may be the only way out for banks amid the pandemic. Given a two-year restructuring window, banks are confident that regularising retail portfolios may not be a difficult task.
The Reserve Bank of India (RBI) rolled out a slew of measures last week to help small borrowers tide through the second wave of the pandemic. In a circular dated May 5, the banking regulator said individuals and small businesses with loan exposure of less than INR25 crore and did not opt for the restructuring last year can do so now if the monthly instalments are paid till the end of FY21.
Borrowers in this category who had recast their loans last year under restructuring 1.0 (as bankers term it) may be offered some moratorium to extend the tenure of repayment by another two years. Lastly, small businesses or micro, small and medium enterprises (MSMEs) that have already opted for restructuring can approach banks to review their working capital limits to mitigate near-term cash flow crunch.
There is a latent messaging in these measures. The pain in the retail and MSME segment is real and it could balloon into a crisis in the absence of timely intervention. The share of retail loans to overall credit has increased from 21.3% in FY16 to 29.1% in FY21, and hence it’s no longer a segment to be ignored. This is why small borrowers are for the first time at the fore of regulatory forbearance. Previous recast plans have been specific to corporates.
The initial response to restructuring 2.0, however, seems to be muted. According to banking analysts, this is largely because last year’s recast plan itself had seen tepid participation. But as analysts at ICICI Securities point out, restructuring 1.0 co-existed with a moratorium — thereby negating the overall stress in the system.
“When you give an extended time period, some may end up paying perhaps three or four out of six instalments, which is still better than not having any instalment repaid.”
— Rajesh Kumar, managing director and CEO, TransUnion Cibil
Demand for restructuring 2.0, though, may see a spike with a wave of uncertainty gripping the economy as India’s uphill battle with the pandemic continues.
“If the crisis is managed in one-two months, the impact will be limited. But if it lasts for six months, it will have a greater impact,” says Krishnan Sitaraman, senior director – financial sector ratings & structured finance ratings, Crisil.
Meanwhile, gross non-performing assets (NPA) ratio in retail for most banks in FY21 was almost twice their average recorded between FY15 and FY20. Hence, without regulatory cushion the segment may crumble given the magnitude of economic downturn. Sitaraman anticipates FY22 gross NPAs to rise from 8.1% in December 2020, although it may not surpass the FY18 peak of 11.35%.
As for financials, analysts at Jefferies note that a 25 basis points (bps) increase in provisions can impact banks’ earnings by 5%–16%. While the top three private banks are relatively insulated, pressure could be higher on non-banking finance companies (NBFCs) and public sector banks (PSBs).
Can restructuring 2.0 turn the tide?
While retail loans in India had a moment of reckoning in 2008 following the global financial crisis, trouble was largely with respect to credit card portfolios when gross NPA peaked at 10% in FY09.
In a sense, the microfinance crisis of 2010 gave a good insight on how political intervention could completely alter repayment behaviour, which subsequently led to many lenders to microfinance institutions going belly up. But in both instances, the focus was to contain the collateral damage to the banking sector.
An attempt to roll out a solution for borrowers to normalise their credit behavior wasn’t the priority in both the cases, and instead, cleaning up the lenders’ books took precedence. This makes restructuring 2.0 a worthy regulatory intervention, and also the first of its kind, as it aims to help borrowers and lenders in equal proportion.
Will the loan recast work?
Historically, loan restructuring has been synonymous with ‘evergreening’ of loans. Recent examples include Flexible Structuring of Long-Term Project Loans to Infrastructure and Core Industries in 2014 and the mass corporate loan-recast plan under former RBI governor Raghuram Rajan a year later, which eventually resulted in over 80% of restructured loans being written off by banks.
However, Sitaraman believes that it’s unfair to extend the comparison to retail loans. For one, corporate lifecycles are longer and business normalisation plays out in three-five years. “Whereas for small borrowers, two years is a good enough period to regularise their accounts,” he says.
According to Rajesh Kumar, managing director and CEO, TransUnion Cibil, an option to recast loans reduces the probability of banks having to take a full hit on their portfolio. “When you give an extended time period, some may end up paying perhaps three or four out of six instalments, which is still better than not having any instalment repaid.”
However, MSME loans could be a tricky aspect and Sitaraman doesn’t rule out a sharp rise in delinquencies despite the forbearance. MSME book for the banking system has increased to INR8.9 trillion from INR7.5 trillion a year ago and much of the addition came from the government’s Emergency Credit Line Guarantee Scheme (ECLGS) that was rolled out last March. “This has helped banks stabilise and build the MSME book,” says Kumar.
While banks haven’t revealed much on MSME loans restructured so far, with ECLGS weaning off it may be about time that the lid cracks open. “Increasingly, it’s becoming difficult to gauge how much pain is caused to MSMEs due to the pandemic and whether they are well-placed to recover, even if some bank aid is given to them,” a senior executive at a public sector bank tells ET Prime.
Bankers believe that extending working capital limits may not be an easy call to take at this juncture. The gross NPAs for MSMEs stood at 12% in September 2020, largely unchanged from a year-ago level owing to a standstill on NPA recognition and credit growth propelled by the ECLGS, according to the RBI’s financial stability report published in January 2021.
If bankers opt to remain cautious on this portfolio, a stance they have taken on MSMEs since FY19, there may be just a handful of borrowers who could benefit from restructuring 2.0. In fact, should restructuring as an exercise prove fruitful, it will be imperative for banks to pick a side — quality or growth.
The impact on growth
For private lenders barring HDFC Bank, retail loan growth has far outstripped the corporate book. The story has been no different for PSBs until the December quarter (March quarter results are awaited). Private banks in FY21 posted a 14%–17% year-on-year growth in their retail portfolio, while for HDFC Bank that number halved to 7.5% from a year-ago level.
Banks are riding high on the retail segment though growth is way off the prime levels seen in FY18. Bank stocks have significantly rebounded from their March 23, 2020, multi-year lows and the sector emerged as the best performer in 2020. Valuations, too, have bounced back owing to the earlier estimated growth potential. But that will change, if growth falters once again.
Analysts at Jefferies estimate that a 200bps year-on-year reduction in loan growth can impact earnings by 1%–6% and a 300bps lower fee can impact earnings by 1%–4%. Considering how banks have refrained from giving any guidance on growth for FY22, following a likely lacklustre first quarter of FY22, the brokerage’s estimates may well play out.
“Right now, again, given the second wave of Covid-19 that we are seeing currently, we’ll have to just wait and see how this trajectory unfolds, how the vaccination drive kind of goes ahead, [and] what steps are taken in terms of lockdowns and restrictions. So, all of that we will have to kind of wait and watch for, maybe a month or two, before one can comment on a more precise outlook,” ICICI Bank told its investors in its fourth-quarter earnings call.
However, here’s some respite for borrowers. Customers who opt to recast their exposure will not see their credit scores impacted, though their accounts will be tagged as ‘Restructured vide RBI circular May 5, 2021’. In other words, for lenders, the customer pool remains intact, though the question is their willingness to consider such borrowers.
“If lenders adopt a highly conservative attitude towards otherwise good customers because they are restructured, then they will struggle to grow without the denominator support along with the risk of worsening their NPAs”, Kumar points out. But some bankers differ.
“When we know that a borrower’s financials are stretched, why would banks cross-sell or up-sell to such a customer?” the head of retail assets at a mid-sized bank points out, adding, “The focus would rather be on quality preservation than growth, at least till economic activities normalise”.
Further, with the pool of credit worthy customers — prime and above with a credit score of 731 and more — gradually reducing, growing a quality book will be the key challenge for banks in FY22, whether or not loans are restructured.
The bottom line
With the regulator having done its part, the onus is now on banks to ensure that restructuring 2.0 doesn’t end up as an exercise of kicking the can down the lane.
That said, the process of preserving asset quality could come at the cost of growth, profitability, and fee income. But if it could eventually lead to better capital utilisation, that should assume priority over other factors.
(Graphics by Mohammad Arshad)
( Originally published on May 10, 2021 )