The latest Financial Stability Report from the Reserve Bank of India (RBI) suggests that the banking sector continues to be deep in crisis. In the previous report, in December 2017, the central bank had estimated that, in its ‘baseline scenario non-performing assets’ (NPAs) would peak in September 2018 at 11. 1 per cent of all advances, after hitting 10.8 per cent in March 2018.
By March 2018, the NPA ratio stood at 11.6 per cent. The public sector banks, which own about 72 per cent of total advances, saw NPAs hit 15.6 per cent of all advances by March 2018. Private bank NPAs have risen to a more moderate 4 per cent, from 3.8 per cent in September 2017.
The major problem is with corporate loans. Corporate NPAs amount to 22.8 per cent, up from 19.4 per cent. NPAs from the retail segment remain stable at 2 per cent. Agriculture has an NPA ratio of about 7 per cent. Services has an NPA ratio of about 6 per cent. About 48 per cent of NPAs are provisioned. Bigger borrowers (with over Rs 50 million in bank loans) are responsible for over 85 per cent of NPAs. The new Insolvency and Banking Code might help with recoveries but the haircuts will be substantial.
The FSR contains updated projections of the NPA situation. In the baseline scenario, where macro-economic conditions remain much the same, it projects NPAs will touch 12.2 per cent by March 2019. PSU banks will register NPAs of 17.3 per cent by then. Six PSU banks will be below the required capital adequacy ratio.
Historically, the baseline scenarios have underestimated future NPAs by about 3 per cent. Indeed, the “severe stress” estimates have been consistent underestimates of reality. The RBI’s “Severe Stress” scenario for June 2018, as opposed to the baseline, estimates that the NPA ratio could rise to 13.3 per cent. Given a deteriorating global scenario, the ‘Medium Stress’ scenario (where NPAs hit 12.7 per cent according to projections) or Severe Stress is more likely than baseline.
Even the 12.2 per cent number will amount to Rs 9.3 trillion or more. In nominal terms, that’s around 6 per cent of GDP. A massive amount of recapitalisation will be required - far more than the Rs 2.2 trillion that the government has estimated. In realistic terms, we may be looking at Rs 4 trillion for recapitalisation, given higher BASEL III capital adequacy norms.
It won’t be easy for the government to find that money. Deals like IDBI-LIC takeover where the insurer coughs up Rs 100 bn or more of cash sourced from individual policy holders will be tempting. But there aren’t too many such cash-rich organisations for the Government of India to raid. Multiplying the scale of the envisaged recapitulation bonds, which the banks subscribe to, and then passing that money back to the banks, is a possibility. But even that will be hard to do.
The latest numbers make the PSU banking sector look even more toxic than after the March 2018 results. It’s hard to see investors willing to stay with these institutions unless there’s a dramatic improvement in balance sheet stability.
There are broader implications as always when a financial crisis seems imminent. If the banking sector is in this sort of a mess, it cannot disburse too much credit. One rule of thumb about India’s economy is that banking credit growth is historically 2.5x of real GDP growth. That would mean credit growth of 18-19 per cent to sustain consistent GDP growth of 7.5 per cent.
Last fiscal (2017-18) saw credit growth of 10.5 per cent while the Gross Domestic Product (GDP) supposedly grew at 6.7 per cent. It’s hard to see credit growth more or less doubling while banks struggle to put balance sheets in order. There have been many question marks about the reliability of GDP estimates in the past few years. Those questions will become more pointed now.
Things will eventually get better. But they may get much worse before that. Avoid corporates that need high leverage, and lots of working capital. If a company cannot grow out of internal accruals, it will find it hard to borrow what it needs to expand. A low debt:equity ratio and the ability to generate steady cash profits will become prized attributes. Firms that possess such characteristics could be the ones worth looking at, until the banking sector stabilises.
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Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper