Financial Stability | NPA cycle over, but where are banks going to get growth capital?

Here’s the good news. In its June 2019 financial stability report (FSR), the Reserve Bank of India has said that the non-performing assets (NPA) cycle seems to have turned around. Of course, in the December 2018 FSR too, the regulator had said that the environment for banks was improving gradually.

Financial numbers support this declaration. The gross NPA ratio has declined to 9.3 percent by the end of March 2019 from 11.6 percent a year ago. Restructured standard assets are only 0.4 percent of all advances. The improvement in asset quality has been broad based, with state-owned banks showing a decline of 3.5 percentage points. Apart from agriculture, NPA ratios improved across borrower categories as well. Moreover, for large borrowers (where banks have exposure of at least Rs 5 crore), the proportion of loans showing any signs of stress (even if it was just 30 days past due) came down from 25.3 percent in September 2018 to 20.9 percent in March 2019.

RBI’s macro-stress tests also project that the system wide NPA ratio will decline from 9.3 percent in March 2019 to 9 percent in March 2020 under its baseline assumptions including 7 percent GDP growth

That said, there are still a bunch of concerns for banks in the coming 12 months. Key among them is the need for capital. Under RBI’s baseline scenario (without taking into account any capital infusion from the government), system level capital adequacy ratio is projected to come down to 12.9 percent in March 2020 from 14 percent in March 2019. As many as five banks will have a capital adequacy ratio below the regulatory minimum of 9 percent by March 2020. If macroeconomic conditions deteriorate, then as many as 9 banks could see capital levels fall below the threshold, the report warned.

While the NPA problem might be over, banks, especially state-owned banks, would need growth capital.  This is not going to come from internal accruals. As the FSR points out, state-owned banks continue to make losses. While the NPA cycle might well be turning, the RBI’s new framework for stressed asset resolution and ageing NPAs on their books could still lead to more provisioning and higher credit costs.

Moreover, there is little visibility on recoveries. While the government has increased the manpower at NCLT, resolution through the insolvency and bankruptcy code is for the most part still not taking place within prescribed time limits.

Raising capital from the markets also looks difficult given the risk perceptions in financial markets, the NBFC crisis and the downgrades by rating agencies.

As usual, the government has to take a call on equity infusion. The interim budget did not make any provisions at all. The government’s hands are tied if it wants to demonstrate fiscal rectitude. But at the same time it would want to infuse capital to prop up lending and consumption in a slowing economy. The choice is tough.