Bank balance sheet recovery

Asset quality is improving, but risks remain

Asset quality in the banking system continues to improve. As the latest Report on Trend and Progress of Banking in India, by the Reserve Bank of India (RBI), showed, the gross non-performing assets (GNPAs) ratio in scheduled commercial banks declined from 8.2 per cent in March 2020 to 7.3 per cent in March 2021. According to the RBI’s estimates, the ratio is expected to have declined to 6.9 per cent by end-September 2021. The financial results declared by banks for the December 2021 quarter suggest that the banking sector balance sheet continues to improve. As a report in this newspaper showed on Wednesday, 28 listed banks reported a year-on-year increase in net profit of 64.1 per cent. Profits went up by 21.5 per cent sequentially.

The sharp jump in profits is largely on account of a fall in provisions and contingencies. GNPAs for these banks declined by 3.5 per cent sequentially. Net interest income, meanwhile, improved by about 10 per cent year-on-year. Continued improvement in the banking sector should help boost confidence as it reduces growth and financial stability risks. With the ongoing deleveraging in the corporate sector, India would be well-positioned to invest as the economy recovers. The government is also pushing up capital expenditure in the hope that it will crowd in private investment over time. However, this might take some time as capacity utilisation is still low and the medium-term outlook remains uncertain.

Although credit growth has improved from a very low base, it is being led by the retail segment. Also, as highlighted by the RBI, credit is not flowing to lower-rated firms. At a broader level, although the banking balance sheet is improving, risks remain. For instance, as the support extended to borrowers is withdrawn, provisioning may have to be increased. Profitability may be hit in the coming quarters because of increasing market interest rates. The value of bond holdings by banks may suffer. Also, it’s worth highlighting that a large part of the clean-up in the banking system has happened because of write-offs. This should certainly not be the preferred way as it would require consistent capital infusion. The government, for instance, has infused about Rs 3.5 trillion into public sector banks (PSBs) since 2014.

As asset quality gets better, bank managements must focus on improving lending standards. This is critical, particularly in PSBs, to avoid recurrence of asset quality problems as and when investment revives. Further, the government must strengthen the system for the Insolvency and Bankruptcy Code with the objective of resolving stressed assets in the given time frame. As reported in these pages, compared to the requirement of about 360 members, the National Company Law Tribunal has 63 members. The government must provide the required human resources to the tribunal and facilitate a quick resolution of cases. This will not only help banks but make capital more efficient, in general, and push growth. The government has also set up an alternative mechanism through an asset reconstruction company to resolve stressed assets. However, it remains to be seen how effectively it addresses the issue. As things stand today, the IBC is the best way to resolve bad loans. Thus, the framework must be strengthened.