Bad debts to rise due to Covid, but banks adequately capitalised: RBI FSR

The ferocity of the second wave of Covid-19 has dented economic activity, but monetary, regulatory and fiscal policy measures have helped stabilise markets, and maintain financial stability, says FSR

The Reserve Bank of India (RBI) expects bad debts in the Indian banking system to rise steeply by the end of this fiscal year, but at a rate not as alarmingly high as it was anticipated a year ago, and banks this time are better fortified with capital.

Under the RBI’s macro stress tests, the gross non-performing asset (GNPA) ratio of the banking system may increase from 7.48 per cent in March 2021 to 9.80 per cent by March 2022 under the “baseline” scenario, and to 11.22 per cent under a “severe stress” scenario, but banks have sufficient capital to take care of it “both at the aggregate and individual level, even under stress”, the half yearly Financial Stability Report (FSR), released by the RBI, said.

Interesting to note here is that the RBI was expecting NPAs to climb to 12.5 per cent of advances under its baseline scenario a year ago, which is more than what is envisaged under the current projection’s severe stress scenario. Bad debts under a severe stress scenario in the June FSR 2020 were 14.7 per cent. The better performance this time was “indicative of pandemic proofing by regulatory support”, the report said.

Within the bank groups, public sector banks’ GNPA ratio of 9.54 per cent in March 2021 could edge up to 12.52 per cent by March 2022 under the baseline scenario.

For private and foreign banks, the transition of the GNPA ratio from baseline to severe stress is from 5.82 per cent to 6.04 per cent to 6.46 per cent, and from 4.90 per cent to 5.35 per cent to 5.97 per cent, respectively. 

The system level capital adequacy ratio would moderate only by 30 basis points between March 2021 and March 2022 under the baseline scenario and by 130 basis points (1.30 percentage points) and 256 basis points, respectively, under the two stress scenarios.

The half-yearly FSR report is a collective assessment of the sub-committee of the Financial Stability and Development Council (FSDC) on risks to financial stability and the resilience of the financial system. All regulators take part in making the report, and it is released by the RBI.

The banking system’s capital to risk-weighted assets ratio (CRAR) improved 130 basis points year on year to 16.03 per cent and the provisioning coverage ratio (PCR) stood at 68.86 per cent in March 2021. The capital is well above the regulatory requirement of 9 per cent of the CRAR.

However, there was a need for banks to raise capital further, as the regulators expect credit demand in the coming days, which has to be met by the banks, leveraging on their capital.  

There were nascent signs of recovery, but “new risks have emerged on the horizon,” Governor Shaktikanta Das said in the foreword to the report. Future waves of the pandemic remain a threat, while the firming up of oil prices has added to inflationary pressure. The financial markets may also witness global spillovers amid “high uncertainty”, while there were rising incidents of data breaches and cyberattacks.

This required sustained policy support accompanied by a further fortification of capital and liquidity buffers by financial entities, the RBI governor noted.

The priority, though, “is to maintain and preserve financial stability”, especially at a time when economic activities have been disrupted by the pandemic, and the financial system “can take the lead in creating the conditions for the economy to recover and thrive”, wrote Das.

Banks themselves, though, are witnessing incipient stress in their retail and micro, small, and medium enterprises (MSMEs), even as their exposures to better-rated large borrowers are declining.

Still, large borrowers make up the lion’s share of a bank’s bad debt even now. The share of large borrowers in the aggregate loan portfolio of banks stood at 52.7 per cent in March 2021, but they accounted for 77.9 per cent of the total gross non-performing assets (NPA), which is an increase from the 73.5 per cent of September 2020.

The pandemic, however, has hit consumers and smaller businesses the hardest. Demand for consumer credit across banks and non-banking financial companies (NBFCs) has dampened, and deterioration in risk profile has become evident giving rise to “incipient risk”, the report noted. 

Banks are also saddled with huge government bonds, which also make them sensitive to valuation changes.  

“Going forward, however, their absorptive capacity may be circumscribed by the likely expansion of bank credit in the wake of the recovery,” the FSR report warned.

While credit growth year on year remained anemic at around 5.4 per cent as in March, deposits increased 11.9 per cent, reflecting continued preference for precautionary savings. 

Public sector banks grew their credit book by only 3.2 per cent, whereas their private counterparts expanded their credit book by 9.9 per cent year on year. The foreign bank loan book remained flat.

The overall demand for consumer credit had stabilised after the first COVID-19 wave receded. “The second wave, however, has sharply affected credit demand, with a steep fall in inquiries across product categories in April,” the report said. 

“Close monitoring of MSME and retail credit portfolios is warranted alongside the need for banks to reinforce buffers, improve governance and remain vigilant in the context of global spillovers,” it said. 

The banks have been protected so far by capital infusion and other regulatory dispensation, but the "true state of their balance sheets will be revealed once the effects of regulatory forbearances have fully played out,” the report warned.  

The report also warranted a “close vigil” on the inflation front.  

The regulators were also not in favour of "hasty withdrawal” of stimulus to support growth, as doing so “before sufficient coverage of the vaccination drive can sap macrofinancial resilience and have adverse unintended consequences.” 

"In the most optimistic scenario, the impact of the second wave should be contained within the first quarter of the year, while frictional inflation pressures work their way out over the first half of the year,” it said, advising financial companies to “internalise these expectations into their outlook while staying on guard against potential balance sheet stress.” 

Interestingly, a survey done by the RBI indicated that there was lower confidence about the stability of both the global and Indian financial system. 

"As regards short-term effects of the second wave of the pandemic, respondents were unequivocal that employment, productivity and wages will decline; while prices, debt-to-GDP ratio and size of the Reserve Bank of India’s balance sheet will increase.”