Analysis | Financial Stability Report: How worrying is RBI’s bad loan projection?

Second, compared with the initial phase of Covid-19, there is a gradual pickup in overall economic activities. Most banks have indicated a lower number of loan recast requests from corporate borrowers signalling the overall stress in the sector may not be as big as initially feared. Loan growth has begun to pick up and NPA levels remain on the expected lines. If the economic recovery gains momentum, more number of borrowers may be in a position to pay back money to lenders.

Third, banks have made significant provisions on their NPA books already. This gives investors major comfort with respect to the banking system preparedness to fight NPAs. Even with respect to Covid-19, banks have made aggressive provisioning over the last three quarters.

Thus, one possibility is that RBI’s caution on NPA situation may be a bit of a stretch.

But, the bigger question is what should be done to deal with the existing stock of bad loans? The six-month moratorium and one-time loan recast have given a temporary breathing space for banks to plan their next move but these aren’t permanent solutions. There should be a systematic approach to resolve the NPA book.

For one, a bad bank may be a good idea and its time may have come for effective resolution of stressed assets. A bad bank, an old idea, refers to a separate entity where all the bad assets of the banking industry can be bundled into. This separate entity, managed by asset reconstruction professionals, can then initiate efforts for asset resolution. However, a bad bank can be a reality only if the government takes the lead and provides the initial capital. If this happens, this will free up banks from the existing stock of bad loans and give them space to focus on fresh business.

Also, the government will have to urgently recapitalise weak public sector banks which carry high bad loans on their books. These banks may not be in a position to raise money on their own unlike the bigger ones (SBI, PNB, BoB) and may require handholding from the government. The budget will be keenly watched in this context.

It is also critical that the RBI is given a free hand to do its job. Interventions from judiciary and government on stressed asset resolution has done much damage to the banking sector in the past. The regulator is the best judge of what is good for the banking system.

But, beyond resolution, what is even more important is that the government will have to continue to pump in money to stimulate demand in the economy.

If economic recovery happens sooner than expected, banks will be able to recover pending dues from big borrowers and kick-start the credit cycle. Banks mirror the health of the economy and as one of the former RBI deputy governors famously said, banks cannot outperform the economy.