Bad loans weren’t an alarming word in the banking system until half a decade ago. Bank CEOs kept repeating to analysts that things are under control. All those talks changed in 2014-2015. A massive clean-up process of bad loans initiated by the Reserve Bank of India (RBI) in 2015 under former governor Raghuram Rajan kicked off a painful phase for banks.
They were forced to declare sticky loans hidden thus far in the balance sheets over the next few years. This came at a cost, though. Banks had to significantly increase provisions (money set aside to cover bad loans) subsequently impacting their profitability. The gross non-performing assets in the system skyrocketed to around Rs 9 lakh crore from about Rs 2-3 lakh crore in just five years. With that, bankers thought the pain is over. It was only the beginning.
Second wave of NPAs
Indian banks may now be at the beginning of a new NPA cycle. Warning signals are already visible. The COVID-19 impact on the Indian economy, coupled with some of the schemes launched by the government to contain the problem may actually cause another wave of bad loans in the Indian banking system.
According to India Ratings, COVID-19 may drive total slippages of banks by up to Rs 5.5 lakh crore in this round. To be sure, COVID-19 is only the latest reason. The second round of bad loan build-up had already begun in the sector even before the pandemic hit the economy. Falling revenues were making it difficult for companies to generate enough cash flows to pay back their lenders.
The onset of COVID-19 was the final nail in the coffin. The banking system is already burdened with Rs 8 lakh crore worth of NPAs. According to India Ratings, banks have faced elevated provisions resulting from the corporate stress cycle over FY16-FY20. Banks had largely provided for the existing corporate stress and were progressing towards a more moderated credit cost cycle. But, COVID-19 has changed all calculations.
In the present context, there are primarily a few reasons that will cause a new NPA cycle.
The nationwide lockdown began on March 25. Till now, the lockdown is largely in effect in most parts of the country (with some relaxations beginning now). This prolonged closure has paralysed businesses and resulted in large-scale job losses. According to the Centre for Monitoring Indian Economy, unemployment spiked to 23 percent in April. This will impact the repayment ability of the borrowers and demand for fresh loans. The economic impact of COVID-19 on India is still a big source of uncertainty for policymakers. What we know so far is that the impact will be large and can potentially push down GDP growth to a negative zone. This will have a corresponding impact on the bank NPAs. According to BofA Securities, government-owned banks’ NPAs could go up by 2-4 percent of the credit in the present economic environment. This, BofA says, will result in a recapitalisation requirement of $7-15 billion (Rs 1.14 lakh crore at the upper end). All this would mean that banks are up for a major shock in the post-COVID world.
Govt’s loan push could lead to NPAs
As part of the COVID-19 economic package, the Narendra Modi-led government has announced a series of loan schemes, some backed by government guarantees to small industrial units and non-banking finance companies (NBFCs). These include a Rs 3 lakh crore economic package for micro, small and medium enterprises (MSMEs), Rs 75,000 crore of loans to NBFCs (of which Rs 30,000 crore is a three-month loan scheme fully backed by the government), Rs 5,000 crore for street vendors and Rs 2 lakh crore concessional credit to farmers. Of the Rs 20 lakh crore package, the direct spending is only about one percentage of GDP, the rest include loans through various banking channels and development institutions.
Demand revival key
If one takes a closer look at the economic package, the government has failed to do much to revive the demand scenario. Without demand creation, merely pushing additional credit to the industry will likely add to the bad loan burden of banks. Companies are mostly using this money to pay up their existing obligations, not for extra lending, according to senior bankers who spoke on condition of anonymity.
The fear of COVID has already prompted leading banks to make preemptive provisions in the fourth quarter. Based on India Ratings' vulnerability framework and corporate stress analysis of 30,000 corporates, the total corporate standard-but-stressed corporate pool may increase from 3.8 percent of the total bank credit as of December (pre-COVID-19 levels) 2019 to up to 6.6 percent post-COVID.
“The incremental stress is mainly from sectors including power, infrastructure, constructions, hospitality, iron and steel, telecom and realty. Out of this, the agency estimates corporates exposures of up to 3.2 percent of total bank credit are at a high risk of slippage,” the agency said.
NBFC loans at risk?
Shadow banks are an additional risk to the banking sector. Banks are the major lending sources to NBFCs. Indian banks have a loan outstanding of Rs 8 lakh crore to NBFCs till May end. Much of this money is lent by the non-banks to real estate, mortgage financing and other consumption-related loans. If these loans are not paid back to NBFCs, banks may see further stress from this portfolio. The fundamental question is when the demand situation will revive on the ground.
The government’s Rs 20 lakh crore economic package is only a liquidity relief given through banking channels. It has arguably failed to do something meaningful to give a push to demand. Ultimately, loans are not free money; companies have to repay these loans. If they don’t, this money will add to the bad loan book of banks. The build-up of fresh stock of bad loans in the banking sector is entirely dependent on how soon the economy recovers from the COVID-19 lockdown shock. An early resumption in industrial activities and revival in consumer spending are key. There are no green shoots yet.