Although the Indian economy is on a mend, expected rise in system-wide non-performing loans and deterioration in bank asset quality could knock down a fragile recovery
India continues to limp out of a repression that halted consumer discretionary spending, industrial activity, and labour employment during the nationwide lockdown. Favourable monsoon prospects and unlocking of retail activity are spurring recovery of consumption in rural and urban areas, respectively. COVID-19 in India may have peaked (for now) with average daily cases declining for more than a month. However, these positive impulses could turn for the worse on possible resurgence of virus in some parts of the country. While the possibility of a stringent lockdown akin to that imposed in March to April is remote, any holdback on capital expenditure by larger firms and closures in micro, small and medium sized enterprises (MSME) sector could worsen credit quality, especially following the expiration of loan moratorium plans on 31 August 2020.
In an off-cycle meeting in March and May 2020, the Reserve Bank of India, the country’s central bank, cumulatively reduced the policy rate by 115 basis points (bps) to its lowest record of 4%. It reduced the reverse repo rate under the Liquidity Adjustment Facility (LAF) cumulatively by 155 bps to 3.35% to promote easy fnancial conditions and encourage banks to deploy their surplus funds in productive sectors of the economy. Governing policy support through moratorium schemes on payment instalments was provided to complement monetary and liquidity measures of which MSME customers availing those increased to 78% in August 2020, reflecting both need and stress in the sector.
With the expiration of moratorium schemes in August, India’s banking sector could see a jump in new non-performing loans (NPLs) for the full year ending March 2021. Although the net non-performing asset (NPA) ratio of commercial banks improved from 2.8% in March 2020 to 2.2% by end of September 2020, these are largely driven by loan write-offs. The Reserve Bank has allowed one-time restructuring of debt including extensions or partial conversion of debt to equity. This should reduce slippage in the current fiscal year but may spread recognition of problem assets over the next year or so.
System-wide return on assets and equity (ROA, ROE) turned positive in 2019-2020 helped by surprisingly stable margins, sharp cost controls, and lower credit costs but these remain negative for public and private sector banks. Profitability is expected to remain abysmal in the next two years given the permanent economic losses from elevated credit costs over this year and the next. An increase in the restructured advances ratio to 0.43% at end-September 2020 from 0.36% in March is indicative of incipient stress.
Banks have been strengthening their balance sheets and bolstering their equity bases against foreseeable loan delinquencies. For instance, public sector banks have, compared to a year ago, raised 20% higher capital of $4.9 billion (INR 360 billion) through private placements during 2020-2021 up to the month of November 2020. Indian banks have also built excess provisions to soften the impact of COVIDrelated losses. The non-performing loan (NPL) provision coverage ratios for the banks stood at 72.4%, the highest in the past 25 years.
In terms of capital adequacy, Indian banks’ capital position has consistently improved in capital to risk-weighted assets ratio (CRAR). CRAR stood at 15.8% as of September 2020 exceeding the regulatory minimum of 10.87% percent, although some small banks breached the minimum. The median CRAR of Indian banks is still below their global peers. Going forward, some state-owned banks may report losses and will need to raise capital to avoid breaching the regulatory minimum requirement and to grow. Numerous private and public sector banks are expected to tap the private marker to raise capital despite cash infusions from the government.
A notable theme to watch out for in India is the corporates’ ownership of banks. This could have consequences given the weak corporate governance amid large corporate defaults over the past few years in the country. In the short-term, the ownership raises the risk of biased lending, diversion of funds, and concentration of economic power fuelling the risk of contagion from corporate defaults to the financial sector.