Covid-19 still poses risks for the banking system
The banking sector was expected to suffer significantly because of the pandemic-related economic disruption. India opted for one of the most stringent lockdowns in 2020 to contain the spread of Covid-19. Even as the nationwide lockdown was gradually lifted, local restrictions remained in various parts of the country for quite some time, which affected businesses. Consequently, the gross domestic product in 2020-21 contracted by 7.3 per cent in real terms. Economic activity was again affected by the second wave of the pandemic in the first quarter of the current fiscal year. However, the impact on the banking sector has been limited. According to the latest “Report on Trend and Progress of Banking in India” by the Reserve Bank of India (RBI), the improvement in gross non-performing assets (GNPAs) that started in 2019-20 continued in 2020-21. Accordingly, GNPA as a percentage of total advances for the sector came down from 8.2 per cent in 2019-20 to 7.3 per cent in 2020-21. Provisional data suggest that the ratio further moderated to 6.9 per cent by September-end.
Although data show that the banking sector has weathered the storm, the headline numbers may not be reflecting the actual picture, partly because of the regulatory forbearance. As the report itself notes, granular data presents a more nuanced picture. Credit growth remains tepid, which shows the impact of the pandemic on aggregate demand. Among other measures, the RBI announced two resolution frameworks to provide relief to both borrowers and lenders. As these measures start unwinding, banks may need to make higher provisioning in the coming quarters. They might also need more capital to deal with the stress being faced by several categories of borrowers. Besides, as underscored by the RBI, the primary source of lowering GNPA has been write-offs over the past several years. This suggests that banks would consistently need more capital. In terms of financial performance, profitability in the last fiscal year increased because of a fall in expenditure. Although interest income suffered, it was compensated by higher investment income. Income from trading also improved as banks took advantage of falling bond yields.
Some of the factors that worked for the banking sector over the last fiscal year and the first half of the current year, however, may change significantly. Although the asset quality has improved, the GNPA is still high and, as noted above, could worsen given the stress in the economy. Additionally, investment and trading gains could reverse to some extent because of increasing bond yields. The banking system gained because of excessively accommodative monetary and liquidity conditions. However, the central bank is now in the process of unwinding policy accommodation, which has pushed up bond yields. Further, credit demand in the system remains weak, which will affect the main source of income for the banking system. The non-financial private sector has been saving at the net level over the last few years. This means even if investment demand revives to some extent, which will depend on the broader economic recovery, it will not result in higher demand for credit. A new variant of the virus has again increased uncertainty and states have started imposing restrictions on public movement. Another setback to economic revival would increase stress and adversely affect the banking system.