India’s crucial banking and financial sector, which any government would be hard-pressed to ignore, faces an ongoing mess.
Look at the timeline: in August 2018, IL&FS collapsed; in September 2019, PMC Bank fell; in October 2019, DHFL collapsed; in March 2020, YES Bank was rescued from the brink of collapse; and in November 2020, Lakshmi Vilas Bank had to be rescued.
Five large banks or shadow banks have gone bankrupt in about two years, which results in the failure of a large financial institution every four months.
In all these failures, the banking regulator and the government made the situation more complicated, giving long ropes to management, which resulted in a huge backlash.
But it’s not that. Since August 2020, bad debts, which ideally should have jumped during a recession, have been frozen. This is because the moratorium ended on August 31, but the Supreme Court (SC), hearing a bunch of applications for a moratorium on loans, ordered that no account be classified as non-performing assets (NPA). until further notice. The RBI also announced a program to restructure loan accounts in default for no more than 30 days as of March 1, 2020.
So how are bad loans in Indian banks – a major pain point in Indian growth history – ready for the future? The Reserve Bank of India (RBI) expects the gross NPA of Indian banks to almost double by the end of September this year.
Stress tests conducted by the central bank indicate that the GNPA ratio of all scheduled commercial banks (BSCs) could drop from 7.5% in September 2020 to 13.5% by September 2021 in the baseline scenario. If the macroeconomic environment deteriorates into a severe stress scenario, the ratio could climb to 14.8%, according to RBI projections.
Among banking groups, the GNPA ratio of public lenders of 9.7% in September 2020 could rise to 16.2% by September 2021 in the baseline scenario. The GNPA ratio of private lenders and foreign banks could drop from 4.6% and 2.5% to 7.9% and 5.4%, respectively, over the same period. In the severe stress scenario, the GNPA ratios of PSB, PVB and FB could reach 17.6%, 8.8% and 6.5%, respectively, by September 2021.
At the very least, after the relative freeze, an avalanche of bad debts is expected in Indian banks, if the RBI estimates are correct. This would mean a lot of write-downs in the balance sheet and, subsequently, banks looking for new capital.
To add to RBI’s woes, many banks have calculated the interest on those frozen APNs as part of net interest income (NII) – which explains such huge growth in bank profits in a shattered economy.
Banks, in any economy, by their lending capacity, are the major and most important catalysts of growth. As India tries to bounce back and recover from Covid, the banking sector is the most important cog in the wheel. It is therefore not surprising that a tenth of the economic survey (38 pages) focuses exclusively on the banking sector. After years of turning a blind eye, the economic inquiry has finally attempted to tackle the elephant in the room.
The survey, written by chief economic adviser KV Subramanian, highlighted the dangers of bank forbearance, zombie lending and the constant greening of loans. He also talks about the dangers of substandard loans.
But more importantly, another round of balance sheet cleaning, or Asset Quality Review (AQR), of Indian banks – a move that is likely to send the Reserve Bank of India’s estimates on bad debt.
In 2015, RBI, under former Governor Raghuram Rajan, launched an AQR to clean up bank balance sheets. The cleanup gained momentum under the leadership of Urjit Patel. However, after Patel’s untimely exit, the AQR went behind the scenes.
With all this focus on the bank in the economic survey, industry insiders believe the budget will have a lot in store for the banking sector, especially on the issue of bad debts and recapitalization.
The survey also highlighted governance issues in the lending process. But that’s for the RBI to decide – there are rules about it, it’s just that the central bank needs to buckle up on the governance front and be more proactive.