Banking Central | Severe Omicron wave can upset bad loan math

Omicron variant [Representative image]

The banking system mirrors the state of the economy. What happens in the economy is reflected in the growth of banks and their asset quality almost instantly.

In India, banks went through a tough phase since the start of COVID-19 in 2020, when most states went into a lockdown, affecting the cashflows of companies. Banks feared large-scale loan defaults. But an immediate shock was averted due to the timely intervention of the Reserve Bank of India.

The RBI asked banks to offer a six-month repayment moratorium for all term loan borrowers (in the first wave) and allowed additional relaxations in the second wave wherein stressed borrowers were given up to two years for repayments. That saved a lot of pain for both banks and borrowers.

Also, the liquidity window was kept open throughout the COVID-19 phase in the form of subsidised credit schemes by the government and special liquidity operations by the central bank.

But the bad days may not be over.

Just when everyone thought the COVID-19 scare was getting over, Omicron has emerged as the next big concern. Cases are spreading fast. But how big will be the impact on the banking sector? There is no certainty on what course Omicron will take.

Banks better prepared

The general consensus among analysts is that banks are much better prepared at this point to handle a potential third wave compared with the initial shocks.

That’s because most banks have provided enough money to cover potential losses and most stressed cases have already been addressed. In the event of a mild third wave, banks wouldn’t be very worried about asset quality impact. But if the nation goes back to a prolonged lockdown, as was the case during the first wave, things could turn bad yet again.

In such a scenario, what else can the regulator do to help stressed borrowers? Can it offer another round of restructuring or a moratorium? To be sure, the RBI has done a lot already to alleviate stress on borrowers. It has already extended two rounds of loan restructuring schemes and the moratorium.

For borrowers too, back-to-back loan recasts aren’t good in the long term. It certainly is an immediate relief. However, a loan restructuring exercise in the form of a prolonged payment holiday can significantly add to the interest burden of a borrower when the regular payment schedule kicks in. Several small businesses had to shut down due to COVID-19.

An online survey conducted by National Small Industries Corporation Ltd. found that about 9 percent of micro, small and medium enterprises closed down as a result of the pandemic.

The survey conducted in August last year covered 5,744 MSMEs in 32 states/Union Territories and found that 91 percent of them were functional.

A severe Omicron spread could impact the sector hard in terms of both growth and asset quality. The RBI expects the gross non-performing assets (GNPA) ratio of banks to worsen to 9.8-11.22 percent by March 2022. But a severe Omicron wave has the potential to upset predictions of bank asset quality.

(Banking Central is a weekly column that keeps a close watch and connects the dots about the sector's most important events for readers.)