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What is the actual COVID impact on bank NPAs?

Indian banks may be looking at a prolonged period of uncertainty on asset quality front for about two years on account of significant restructuring exercise for COVID-linked loans.

September 23, 2020 / 03:47 PM IST
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Six-month loan moratorium and one-time loan restructuring may have come as a boon for COVID-hit borrowers and lending institutions to delay the pain. But analysts have raised warning signals on the likely build-up of hidden stress in the banking system on account of these measures.

Indian banks may be looking at a prolonged period of uncertainty on asset quality front for about two years on account of significant restructuring exercise for COVID-linked loans. Under the restructuring, banks relax repayment terms for stressed borrowers without classifying these loans as bad loans. In fact, banks have already begun the process of rolling out the COVID resolution schemes by putting up FAQs and online tools on websites. The idea is to help borrowers understand their eligibility and the processes that need to be followed.

At least two banks, State Bank of India (SBI) and HDFC Bank, have published the details of one-time loan restructuring schemes on their websites. Others are expected to follow. Under this, banks can offer up to two years of loan moratorium extension to those borrowers whose cash flows have been impacted by COVID. While retail borrowers can apply on the websites, corporate customers will have to discuss their eligibility for the scheme with banks on a case-to-case basis.

“The restructuring will mean actual NPAs will remain suppressed till the extended moratorium period gets over,” said Jaikishan Parmar, an analyst at Angel Broking Ltd. “There will be a systemic impact on account of the restructuring process,” said Parmar.

To fight COVID, the Reserve Bank of India (RBI) permitted financial institutions to offer a moratorium on all term loans. This period expired on August 31. While the regular repayments should have started by September 1, the Supreme Court has directed banks not to tag accounts as fresh NPAs that are standard as on March 31.


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The restructuring facility up to two years under the COVID resolution framework would mean the moratorium can get extended for two more years. Analysts estimate about 5-8 percent of the total loan book to go under restructuring given the stress in the banking system.

Total gross NPAs of Indian banks stood at around 8.5 percent in March 2020. According to the RBI, this ratio could rise up to 15 percent by March 2021 in a worst-case scenario. A significant chunk of both individual and corporate borrowers have availed moratorium facility already. Going by the RBI’s latest Financial Stability Report in July, 56.2 percent of retail loans were under moratorium as on April 30 against only 39.1 percent of corporate loans.

Massive restructurings done in the past have contributed to hidden NPAs. Till 2015, when the RBI initiated a major asset quality review (AQR), banking system gross NPAs were just around Rs 2-3 lakh crore. However, after the AQR, the NPAs shot up to Rs 8-9 lakh crore after banks were forced to dig out NPAs from their balance sheets. The restructuring exercise, this time, has been designed with much more caution, in a time-bound manner.

How does the restructuring plan work?

Under the RBI guidelines, accounts classified as standard and not in default for more than 30 days as on March 1 shall be eligible for restructuring. The invocation of the resolution plan can be done until December 31, 2020. The scheme will have to be implemented within 90 days of such an invocation. The RBI had appointed an expert panel under KV Kamath to decide the financial ratios for restructuring. The panel identified 26 sectors for which five key financial ratios were identified. The central bank has broadly accepted the panel recommendations.

As per the Kamath panel, nearly 72 percent of the corporate debt falls in identified stressed sectors, including traders, metal, textiles, NBFCs, infra/construction, power, real estate and auto. According to rating agency Crisil, nearly two-thirds of the companies rated by it would be eligible for one-time debt restructuring based on the parameters proposed by the KV Kamath Committee.

“CRISIL studied its rated portfolio of more than 8,500 companies after sorting them by rating, sector and moratorium availed. The broad-level assessment is based on financial projections and excludes small and medium enterprises (SMEs) and financial sector companies (please refer to annexure for methodology),” the agency said.

Is restructuring just delaying the pain?

It is not a solution by itself. Restructuring gives only an option to companies for relaxed repayment terms. Companies will need to repay the loan once this is over. In the past, a good chunk of the loans that were restructured had gone bad.

“Given the impaired ability to generate healthy cash flow, some of these disruptions may continue for a few more months. We believe a good portion of these restructured accounts may eventually turn non-performing,” said Anand Rathi in its report.

In the past, the banking system has attempted multiple loan recast mechanisms, including corporate debt restructuring (CDR), joint lenders forum (JLF), and Strategic debt restructuring (SDR). However, in February 2018, the central bank withdrew all such schemes with Insolvency and Bankruptcy Code (IBC) becoming the main option for banks to resolve stressed assets.

Banks may be preparing for bad loan shock by aggressively looking at the asset reconstruction space. According to a report in the Economic Times, Brookfield Group is set to re-enter the asset reconstruction space by teaming up with SBI and HDFC. Macquarie Capital has estimated that stressed assets could more than double and touch nearly 20 percent by the end of FY21. Bad loan ratio at the end of March 2020 stood at 8.5 percent.

“As per our estimates, we believe overall stressed assets for banks is expected to touch 20 per cent by FY21E which is perhaps the highest observed in the history of the banking system in India and also one of the highest in the world,” said Suresh Ganapathy, Associate Director, Macquarie Capital.

So what lies ahead for banks if the economic activity doesn’t recover as expected? Analysts expect a majority of the restructured loans to go bad, impacting the financial health of banks and forcing the regulator to initiate another clean-up cycle.
Dinesh Unnikrishnan
first published: Sep 23, 2020 03:46 pm

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