The Govt and the RBI must urgently reassess the moratorium policy and limit it only to the hardest-hit, address the delays in IBC resolution and not drive away depositors
After the release of the Reserve Bank of India’s (RBI’s) half-yearly Financial Stability Report (FSR) on July 24, shares of banks and finance companies were battered at the stock market. Though the private banks (PVBs) like ICICI, HDFC, Axis Bank, Bandhan Bank got seared, the public sector banks (PSBs), too, bore the brunt of the bloodbath on the bourses. The mayhem exposed the structural weaknesses of the Indian banking system and the severity of the Non-Performing Asset (NPA) crisis looming over them.
As the RBI Governor Shaktikanta Das emphasised (and his sentiment was echoed by the Chairman of the 15th Finance Commission) the soaring NPAs and the consequent capital erosion of the banks would need immediate recapitalisation of both PVBs and PSBs.
To alleviate the pandemic-created stress on borrowers, the RBI has already placed a moratorium on the payment of loan instalments and deferment of interest payments till August 31. However, the banks are fearing — as articulated by the HDFC Chairman — that even solvent borrowers may take advantage of this relaxation and not repay their loans. This would further worsen the financials of the banks.
The FSR has also acknowledged that there is a major risk that the moratoriums may have serious implications on the financial health of the banks. Overall, about 50 per cent of all loans — 65 per cent of Micro, Small and Medium Enterprises (MSME) borrowings and 56 per cent of retail loans — were under moratorium as on April 30, against only 39 per cent of corporate loans. The PSBs have a larger share — 58 per cent, 82 per cent and 80 per cent respectively for corporate, MSME and individual loans, as against 20 per cent, 43 per cent and 34 per cent respectively for the PVBs.
As far as Non-Banking Financial Companies (NBFCs) are concerned, 56 per cent, 61 per cent and 46 per cent of the loans are under moratorium respectively for these categories. The scenario is really disquieting. The RBI has assumed a contraction of the Gross Domestic Product (GDP) by 4.4 per cent, gross fiscal deficit of 10.9 per cent and Consumer Price Inflation (CPI) of 4.1 per cent as the baseline scenario assuming steady recovery from the second-half of the current fiscal. The GDP contraction and fiscal deficit numbers may be a tad too optimistic, given the severe economic disruptions with no end in sight.
The FSR has stated that the Capital to Risk-Weighted Assets Ratio (CRAR) of Scheduled Commercial Banks (SCBs) stood at 14.8 per cent while their Gross Non-Performing Asset (GNPA) ratio stood at 8.5 per cent in March. But it projected that the GNPA ratio may worsen further to 12.5 per cent by March 2021 under the optimistic baseline scenario and may escalate to 14.7 per cent under a severely-stressed scenario.
The implications of these numbers are indeed very serious. As of March, the total NPAs of SCBs stood at Rs 8.62 lakh crore; at the baseline scenario which seems a bit hopeful, this would rise to around Rs 13 lakh crore and at the worst case scenario to Rs 15 lakh crore, at which level, all undercapitalised and overleveraged banks would cease to be going concerns.
In fact, the pandemic has wiped out all the work done so far by the SCBs by using a large part of their capital to correct their balance sheets — which was so assiduously pursued by the RBI during the last few years. This has seen a steady decline in their GNPA ratio from 11.5 per cent in March 2018 to 8.5 per cent in March this year. Though this reduced their CRAR, however, it still remained above the Basel III-compliant RBI norms. Now, the loans are likely to rise to a 20-year high as a result of the crisis triggered by the pandemic.
As the RBI Governor said in the foreword to the FSR, “The financial system in India remains sound. Nonetheless, in the current environment, the need for financial intermediaries to proactively augment capital and improve their resilience has acquired top priority. In the evolving milieu, while risk management has to be prudent, extreme risk-aversion would have adverse outcomes for all.”
Under the current crisis, risk aversion, both by banks and borrowers, is only to be expected as evidenced by the banks parking their excess liquidity with the RBI instead of lending. Credit demand has not picked up despite the easing of the lockdown and financial vulnerabilities are likely to be amplified, leading to a further deterioration in the asset quality of the banks due to the piling up of mountains of bad loans.
As a 90-day window is given for paying the loan instalments to keep the loans from being classified as NPAs, the exact position would be known only in December after the expiry of the moratorium on August 31. But there is an urgent need to recapitalise the banks — both PSBs and PVBs — for building stronger buffers for them to be able to absorb the losses.
The recapitalisation bond route by which the Government issues bonds to the banks, which promptly invest them in Government securities, is nothing more than an accounting trick. Apart from increasing the Government’s interest liabilities, it rarely addresses the deeper structural problems of the banks.
While the GNPA ratio of PSBs may increase to 15.2 per cent under the baseline scenario (16.3 per cent under the worst-case scenario), the ratios of the PVBs and even the foreign banks are likely to increase to 7.3 per cent and 3.9 per cent, respectively. Erosion of the capital will shrink the system-level CRAR of the banking sector as a whole from 14.6 per cent in March to 13.3 per cent by next March under the baseline scenario and to 11.8 per cent under severe stress conditions.
Five banks will fail to meet the minimum prescribed CRAR level of nine per cent by March 2021 — five more will be close (under 10 per cent) without merger or recapitalisation which might increase their systemic resilience. However, mergers of PSBs, now practically stalled because of the lockdown, have their own problems. The NPAs of the State Bank of India (SBI) worsened after its merger with associates two years ago, with write-offs and persistent slippages eating into profit and capital both, besides impeding the growth of credit.
Other mergers — Bank of Baroda (BoB) with Vijaya Bank and Dena Bank and Punjab National Bank’s (PNBs) 1993 merger with the New Bank of India also faced many problems. It is unlikely that the current mergers of healthy banks with weak banks will improve the health of the banking system as a whole; in any case, they will not cause any significant reduction of the NPA ratios of the amalgamated banks. Then there is the added danger of spillover effects from the NPAs of NBFCs, which are still unable to recover from the IL&FS shock of 2018. Bank lending to NBFCs had increased dramatically from Rs 3 lakh crore in December 2016 post-demonetisation to Rs 8 lakh crore in May this year. Any increase in their NPAs will automatically trigger a contagion, leading to further deterioration of the banking system. The gravity of the situation cannot be overemphasised.
The structural problems with the recovery of bad loans have remained unresolved even after operationalisation of the Insolvency and Bankruptcy Code (IBC). Of the total claims of Rs 3.52 lakh crore from 190 companies (till December 2019), Rs 1.52 lakh crore (43 per cent) has been recovered, which of course was a significant improvement over the earlier recovery rate of 10 per cent. But only two cases — Bhushan Steel and Essar Steel — accounted for 49.5 per cent of the overall recoveries.
Given the huge number of caseloads — 1,961 as of December 2019 —and the time taken for disposal by the National Company Law Tribunal (NCLT), the system is already getting clogged like never before. With low credit offtake and higher NPAs, banks will be forced to further lower the deposit interest rates — already at the rock-bottom — and drive depositors towards the equity market or gold. This is hardly a recipe for revival. The Government and the RBI must urgently reassess the across-the-board moratorium policy and limit it only to the hardest-hit, address the delays in IBC resolution and not further alienate and drive away the depositors.
(The writer is a former Director General at the office of the CAG of India and an academic.)
