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Exclusive Interview | Morgan Stanley's Sumeet Kariwala says impaired loan formation will remain elevated in H1-F22; mid-sized banks, PSBs to see relatively higher impact

According to Morgan Stanley, job losses in the formal segment have been contained so far but relatively higher impacted segments are the self-employed retail and MSME segment. Commentary from banks highlight material drop in collection efficiency during the past month in retail, MSME, Kariwala said.

June 08, 2021 / 10:26 AM IST
Sumeet Kariwala, Executive Director, India Banks Analyst, Morgan Stanley

Sumeet Kariwala, Executive Director, India Banks Analyst, Morgan Stanley


The Indian banking sector will see elevated levels of impaired loans in the second half of fiscal year 2022. While the Gross NPLs of banks will continue to move lower in FY22, the overall impaired loans will increase by 1-2 percent led by restructured loans, said Sumeet Kariwala, Executive Director, India Banks Analyst, Morgan Stanley in an exclusive interview to Moneycontrol on June 8.

Kariwala was speaking on the sidelines of the Morgan Stanley Virtual India Summit. There could be downside risk in retail/SME depending on how COVID-19 plays out, Kariwala said. While large banks have unutilised contingency buffers, mid-sized banks, SoE banks (ex SBI) will see relatively higher impact, Kariwala said.

According to Morgan Stanley, job losses in the formal segment have been contained so far but relatively higher impacted segments are the self-employed retail and MSME segment. Commentary from banks highlight material drop in collection efficiency during the past month in retail, MSME, Kariwala said.

“Extent of stress will depend on the duration of lockdown which remains uncertain. Government measures, particularly ECLGS really helped MSME/self-employed segments,” Kariwala said. Based on Morgan Stanley’s current estimates, Indian PSBs will have a potential capital requirement of $6-$7 billion over the next two years, Kariwala added.

Edited Excerpts:

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What is your outlook for Indian banking sector over the next 6-12 months?

We remain constructive on Indian banks, with a preference for large banks. This is given significant improvement in balance sheet strength despite the first COVID-19 wave. Both capital and coverage on impaired loans have improved significantly during the Crisis. Yes, there will be further impact owing to the second COVID-19 wave and impaired loan formation will remain elevated in H1-F22.

However, large banks have unutilised contingency buffers, which will help mitigate the impact. Mid-sized banks and SoE banks (ex SBI), on a relative basis will see higher impact, as they have lower coverage and higher stressed loans. This will imply that earnings inflection will likely be a F23 event for these banks.

There is a view that RBI’s COVID-19-relief schemes, including the restructurings announced in two rounds, could lead to an eventual asset quality shock. Your views?

The asset quality outlook is uncertain and yes, there could be downside risk in the retail/SME segment depending on how the various COVID-19 waves play out. Moreover, unlike the first COVID-19 wave, operational challenges have been much higher in the second wave. Having said that, our base case for the system is relatively sanguine given the likely turn in the corporate NPL cycle.

As we know, Indian banks have already gone through a deep corporate NPL cycle, and there hasn’t been any significant lending over the past many years. This drives our conviction on moderation in corporate NPLs, which will help offset the potential challenges in the SME/retail segment and cap any sharp spike in bad loans. Moreover, we have seen strong banks showing significant resilience in asset quality during the first COVID wave and unless the second/third COVID waves are very prolonged ones, we expect the challenge to be manageable for them.

Which are the segments where stress signals are emerging?

As discussed earlier, the impact of COVID-19 has been limited in the mid/large corporate banking segment. Further, job losses in the formal segment have been contained so far. The relatively higher impacted segments would be the self-employed retail and MSME segment. Indeed, the commentary from banks have highlighted a material drop in collection efficiency during the past month in these segments.

The extent of stress will depend on the duration of lockdown which remains uncertain. The government measures, particularly the ECLGS scheme has really helped the MSME/self-employed segment manage COVID stress well, as it enabled unrestricted credit flow at the time of the crisis. The government has further provided relief under this scheme by relaxing the interest moratorium period, as well allowing an additional 10 percent funding to existing ECLGS borrowers. While there could be some delay in NPL recognition following this move, we believe this is necessary given the pandemic.

Where do you see the NPLs of Indian banks in the next few years?

The situation is quite dynamic as of now. Compared to the consensus expectations of a sharp spike in bad loans, F21 has surprised positively. On our estimates, total impaired loans (defined as GNPLs + restructured loans) was broadly stable in F21 at ~8 percent - while GNPLs reduced from ~8 percent to ~7 percent for the system, the increase was owing to higher restructured loans. We believe GNPLs will continue to move lower in F22, but overall impaired loans will increase by 1-2 percent led by restructured loans. The key would be F23, as restructured loans/ECLGS loan book season, and potential weak loans slip into NPLs.

Is an AQR-2 (Asset Quality Review) warranted?

We don’t think so. The RBI has significantly tightened both – the supervision of banks as well the various forbearances available for asset classifications in the past corporate NPL cycle. Yes, the COVID-19 crisis has forced RBI to re-start loan restructuring but this is a necessary measure and most likely a temporary one. There can be some delay in potential NPL recognition.

How severe is the capital shortage of Indian banks?

We have come a long way here. Let’s evaluate this separately for private and SoE banks. Private banks have maintained much higher capital ratios, and have further strengthened this during the COVID-19. On our computations, CET 1 ratio at private banks at >16 percent is one of the highest in many years.

Yes, SoE banks are much lower, and slightly above 10 percent on our computations. However, the situation is significantly better compared to the past 3-5 years. CET 1 ratio at SoE banks, adjusted for 70 percent coverage on GNPLs, has improved to ~10 percent vs. ~7 percent that we saw 3-5 years back. However, SoE banks are still away from being adequately capitalized - there is still some catchup provision left on current impaired loans. Further, the internal rate of capital generation will improve gradually and this implies limited growth capital. These factors will warrant continued capital raising by these banks.

What is your estimate of capital requirement for PSBs in next few years?

The capital requirement at SoE banks will depend on a) provisioning deficit on existing impaired loans as well as potential bad loans owing to the second COVID-19 wave and b) pace of growth acceleration over the next few years. Based on our current estimates, we expect a potential capital requirement of $6-$7 billion over the next two years – this changes materially if the loan growth acceleration at SoE banks is much higher. The positive here is that a lot of SoE banks raised capital from the public market in F21/F22 so far – this has happened after several years and will help fund the potential capital requirement at SoE banks.

RBI has come with new norms capping promoter CEOs and auditor appointments. Your take?

Sometimes, the regulators are forced to make a tough choice. Banking is a leverage business and is systemically important. This calls for higher than normal regulations but at the same time, this can also impede strong and experienced talent from continuing longer at the firm. Hopefully, we can find a better way to tighten regulatory supervision and manage this in the future.

Privatisation of PSBs has progressed at a slow pace. What should be the approach?

I think there are two ways to do this. We agree that the pace of stake reduction at state owned banks has been slower than expected. However, if we look at the pace of private banks loan market share, there has been significant acceleration in recent years. We note that private banks have increased loan market share by >10%pts to ~35 percent over the past five years ending F21. This compares to an increase of ~7%pts during the preceding five years. We expect the pace of private sector market share gains will continue to remain high - this will be helped by a number of new differentiated bank licenses as well as the technology led innovations in the private sector.

Your take on the digital lending space?

Digital lending is the future and there is no doubt about it. Almost every lender has been working on it and has built capabilities to originate loans digitally. The digitisation of data, both in urban and interior India has led to significant expansion in available datasets – while part of this will be publically available post consent, some of that can be better leveraged by right partnerships. The successful digital lending model will need a strong underwriting process as well as collection capabilities. While initially all lenders will do well, we will know the stronger ones when the tide turns.
Dinesh Unnikrishnan
first published: Jun 8, 2021 10:24 am

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