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Economic Survey 2021 calls for another asset quality review, says forbearance can't stay for long

This statement in the survey is significant since a bad loan clean-up will mean banks will see a sharp spike in bad loans from the current level.

January 29, 2021 / 04:14 PM IST

The biggest takeaway for the financial sector in the 2021 Economic Survey, ahead of the Union Budget on February 1, is the call for another asset quality review (AQR) in the banking system. If this happens, it will have huge implications in the banking system in terms of capital requirement and bad loan trend.

“A clean-up of bank balance sheets is necessary when the forbearance is discontinued. Note that while the 2016 AQR exacerbated the problems in the banking sector, the lesson from the same is not that an AQR should not be conducted,” the Economic Survey said.

“Given the problem of asymmetric information between the regulator and the banks, which gets accentuated during the forbearance regime, an AQR exercise must be conducted immediately after the forbearance is withdrawn,” the survey said.

This statement in the survey is significant since a bad loan clean-up will mean banks will see a sharp spike in bad loans from the current level. As on September 2020, around 7.5 percent of the bank loans is tagged as gross non-performing assets (GNPAs). Banks need to set aside money to cover bad loans that impact their profitability.

The GNPA ratio is expected to rise to 13.5 percent in September this year, according to a Reserve Bank of India (RBI) estimate in a base-case scenario. In a worst-case scenario, the GNPAs can shoot up to 15 percent.

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An AQR refers to an aggressive clean-up of bank balance sheets initiated by the RBI to unearth the full impact of the stress in the banking system. This exposes the actual underlying stress on bank balance sheets typically hidden by smart lenders by way of ‘ever-greening’. Ever-greening refers to the practice of banks giving fresh loans to big borrowers to pay up old loans that are on the verge of default.

By doing this, the actual stress in the banking system will remain hidden for a prolonged period. The build-up of such stress can explode at some stage causing broader systemic stress. The idea of an AQR is to avert such an eventuality and identify the problems at the early stages. The RBI had conducted an AQR back in 2015-16 but the survey said the exercise failed to capture ever-greening.

The survey also said the regulatory forbearance announced post-COVID needs to be withdrawn at the earliest. The RBI had announced a series of measures including a six-month loan moratorium, relaxations in certain asset classification norms and a one-time restructuring of loans for COVID-linked stressed assets.

"Remember that forbearance represents emergency medicine that should be discontinued at the first opportunity when the economy exhibits recovery, not a staple diet that gets continued for years. Therefore, policymakers should lay out thresholds of economic recovery at which such measures will be withdrawn," the survey said.

Further, these thresholds should be communicated to the banks in advance so that they can prepare for the same, the survey said. "Prolonged forbearance is likely to sow the seeds of a much deeper crisis. As well, forbearance should be accompanied by restrictions on zombie lending to ensure a healthy borrowing culture," the survey said.
Dinesh Unnikrishnan
first published: Jan 29, 2021 04:14 pm

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