Indian banks are at the end of a prolonged, painful non-performing assets (NPAs) clean-up cycle. The hidden stock of bad loans buried deep in the balance sheets, accumulated over the years of easy money era, prompted the Reserve Bank of India (RBI) to initiate an Asset Quality Review (AQR) in 2015 at the insistence of former RBI governor, Raghuram Rajan.
As a result, the Gross NPAs of banks surged from about Rs 2 trillion all the way to around Rs 9 trillion in a period of just three to four years.
By now, that process is almost over with banks having disclosed most of the problematic large corporate accounts. Many large cases of corporate loan defaults have been pushed to the Insolvency and Bankruptcy Code (IBC) court for quicker resolution.
But the nightmare is not over for banks.
The second round of bad loans could come up with the slowing economy caught in the vicious cycle of consumption slump and policy paralysis. Fresh loans given to companies including those given to small and medium enterprises (SMEs) face risk if the cash flows of companies remain under pressure, thus impacting their loan repayment ability, bankers said.
"There is only so much you can do when economy is not doing well. Lending and recovery depend on economic recovery on the ground," said Naresh Malhotra, a banking consultant.
The consensus among industry leaders is that, right now, most companies in consumer-oriented sectors are operating with less than 70 percent of their capacity. The fate of the next bad loan cycle will depend on how soon the economy recovers.
The pain points
When one analyses the third-quarter (Q3) earnings cards of major banks, a larger trend emerges--though some major, retail-focused banks have reported marginally lower or flat Gross NPA figures, corporate portfolios and MSME segments (that immediately reflect the stress in economy) are showing a slight rise in stress.
Here, the story could take a turn either side depending upon the future course of the economy that has a high correlation to cash-flows of the companies.
In Q3, ICICI Bank reported addition of Rs 2,473 crore in corporate and SME loan NPAs as compared with Rs 1,159 crore in the second quarter and Rs 1,020 crore in the year-ago quarter. During the quarter, the bank converted Rs 845 crore into compulsorily convertible preference shares under the debt restructuring scheme. Including this part, fresh additions come to Rs 3,309 crore.
Take the case of IndusInd Bank. In Q3, the bank reported a significant jump in its gross NPA levels, which rose to 2.18 per cent from 1.13 per cent in the year-ago period. Of the NPA pie, corporate bad loans rose to Rs 3,050 crore from Rs 2,932 crore sequentially. Bad loans in commercial vehicle (CV) loan segment expanded quickly vis-à-vis other segments; from Rs 361 crore to Rs 415 crore on a quarter-on-quarter (QoQ) basis.
PNB’s NPA figures show a different picture. Here the MSME accounts show NPAs at an elevated level. Gross MSME NPAs, in percentage terms, stands at 25.7 per cent of the total loans as compared with 20.7 per cent in the year-ago period. Corporate NPAs are at around 19 per cent, a tad less than a year ago.
HDFC Bank, too has seen its gross slippages inching up in Q3. The bank did not disclose which sectors have contributed to fresh slippages of about Rs 1,500 crore in the quarter. Gross NPAs stood at 1.42 percent. The trend is not different from Karnataka Bank which also posted a rise in gross NPAs from 4.78 per cent to 5 per cent.
Telecom construction sectors are sending out warning signals too. The adjusted gross revenues (AGR) mess telecom companies face and the crisis in the non-banking finance sector could spill over to banks’ balance sheets too. A recent Supreme Court order asked telcos to pay up substantial AGR dues.
According to rating agency, Care, at an industry level banks have seen an improvement in asset quality but provisions are likely to inch up going ahead. "Provisions of scheduled commercial banks (SCBs) are likely to rise in the coming quarters on account of recognition of stressed assets due to exposure to some stressed groups in the non-banking financial companies/ housing finance companies (NBFC/HFC) segment along with other corporates that have undergone structural changes due to t the policy and regulatory measures (real estate and telecom)," it said.
In a note late 2019, Jefferies said that there is a potential 'meaningful divergence' between the ratings and the debt repayment ability of companies. The latest RBI Financial stability report too suggested that RBI NPAs are likely to rise to 9.9 percent by September 2020 from 9.3 per cent in the first half of the current financial year.
In view of the stress in corporate/MSME loan portfolios, banks have scaled down their loan growth. For instance, Kotak Q3 loan growth was slowed to 10.3 percent in December quarter compared with 15.3 percent sequentially. Federal Bank is another lender which has felt the heat of demand slump and chose to lend cautiously. "Overall loan growth slipped further to 13 percent year-on-year (YoY), mainly due to the conscious slowdown in the corporate book," said Emkay analysts in a note.
Will economy recover early?
The banking sector is a proxy to the economy and its health is inseparably linked to how the economy performs on the ground. So, the trend explained above will depend on how soon the economy revives on the ground. Till now there aren’t any strong signals of economic revival.
In Q3, the Indian economy grew by 4.7 percent dragged by manufacturing and lack of private investments. The Gross Fixed capital formation (GFCF), which indicates the investment activity in the economy, contracted by 5.2 percent in Q3 as against a contraction of 4.1 percent in Q2.
An early recovery, at this stage, looks extremely unlikely in Asia’s third-largest economy as none of the domestic growth engines is firing. The lightly regulated shadow banking sector and the mess at co-operative banks add to the financial sector’s woes.
The recent national budget was widely expected to offer the much needed extra spending push to revive the consumer demand. But that did not happen.
Land/labour reforms are absent even after six years of a majority government. Privatisation of public sector banks (PSBs) remains a long-forgotten promise. One of the government's promises after rising to the national scene in 2014 was "the government has no business to be in business". This remains on paper. Unless PSBs are privatised, private investors will be on the sidelines. This has direct implications on the autonomy and efficiency of PSBs.
The government pegged total expenditure for FY21 at Rs 30.42 lakh crore or13.5 per cent of gross domestic product (GDP) compared with a total expenditure of Rs 26.99 lakh crore (revised estimate) or 13.2 per cent of GDP in FY20. That is just 0.3 per cent increase over a year; not what a sinking economy needs.