How severe is the bad loan shock awaiting Indian banks?

Indian banks already have high NPA levels. Total gross NPAs of banks stood around 8.3 percent in March compared to 9.1 percent in the same period last year. NPA level have come down in recent months, but that trend is unlikely to sustain due to the pandemic. In December last year, RBI had predicted NPAs to spike to 9.9 percent by September. But that was prior to the COVID-19 pandemic.

“It is certain that there will be a spike in NPAs from current level. I would not like to put a number as it is difficult to estimate,” said Sanjay Agarwal, Senior Director at CARE Ratings.

Banks build a war chest A number of private banks -- including ICICI Bank, HDFC Bank, Axis Bank and Yes Bank -- have announced plans to raise capital even though they have adequate capital levels. Analysts attribute this partly to expectations of an asset quality shock in the post moratorium period.

HDFC Bank recently said it plans to raise up to Rs 50,000 crore via unsecured perpetual debt instruments, Tier II capital bonds and long term bonds in the domestic market. ICICI Bank plans to raise as much as Rs 15,000 crore in capital via shares or equity-linked securities. Axis Bank plans to raise up to Rs 15,000 crore and Yes Bank, which was recently bailed out by a bank consortium, aims to undertake a follow on public issue of Rs 15,000 crore. That apart, there are other banks, including government banks, which want to raise substantial capital.

In fact, most of these banks had already made substantial upfront provisions to provide a cushion against COVID-19 in the fourth quarter of FY20 itself. “Part of this capital raising exercise could be aimed at taking care of unexpected hike in NPAs while part of it will be used for growth capital,” said Agarwal of CARE Ratings.

In a recent note, Emkay Research said delinquencies in personal, two-wheeler and commercial vehicle loans may accelerate going forward, which, coupled with slower credit growth, will boost NPAs. “Retail GNPA ratio for banks under our coverage stood at 1.5 percent in FY20, which could potentially inch up to 3.5 percent in FY21 with some spill-over effect even in FY22, though better clarity on possible trend could emerge once the moratorium is lifted,” the note read.

Moratorium loans remain tricky On an average, banks have extended the moratorium to at least a quarter of their loan book in the second round (June-August). The quantum of moratorium loans was much higher in the first round (March-May).

However, with the economy opening up gradually, less number of borrowers have opted to defer their EMIs. Even then, the amount of loans that are under moratorium is significant. According to a report by Mint, state-run lenders alone have close to Rs 8 lakh crore loans under moratorium. The country’s largest lender, State Bank of India (SBI), said that even if 5-10 percent of these loans turn NPAs, it could substantially add to the stress in the banking sector.

Banks are unable to assess the exact nature of the stress on their books due to the moratorium. Hence, the only way to prepare for a possible spike in bad loans is to augment capital and make upfront provisions. “It is too uncertain to make an estimate. The honest answer is I don’t know,” said a senior banking executive when asked about the house estimate on NPAs. Not all moratorium loans are stressed.

COVID stress tests Das has asked banks to undertake COVID stress tests on their portfolios and focus on building buffers and risk-management. These measures, which are already underway, could help Indian banks face the eventuality of a second NPA wave.

Post the massive bad loan clean-up exercise initiated by Raghuram Rajan in 2015, the industry had seen a major increase in NPAs in just four years to Rs 9 trillion from about Rs 2 trillion.

“We have recently advised all banks, non-deposit taking NBFCs and all deposit-taking NBFCs to assess the impact of COVID-19 on their balance sheet, asset quality, liquidity, profitability and capital adequacy for FY21,” Das said.

“Based on the outcome of such stress testing, banks and non-banking financial companies have been advised to work out possible mitigating measures, including capital planning, capital raising, and contingency liquidity planning,” Das added.

While stress testing is welcome, continuing uncertainty on the extent of the COVID crisis makes it difficult for banks to make a thorough assessment, bankers said.

What happens if NPAs spike? If NPAs shoot up, banks will have to set aside huge provisions to cover likely losses. Under RBI norms, banks have to make provisions and this varies depending on the deterioration in asset quality. A loan account where there is no possibility of recovery left may need up to 100 percent provisioning. High bad loans and subsequent provisioning impacts profitability of banks and weakens their balance sheets.