After the moratorium: Banks have to face their bad loan problem, again

Indian banks will have a hard task when RBI's moratorium ends this month. They will have to account for the impact of the coronavirus pandemic on their balance sheets. Bankers claim loan repayments are rising, but a true picture will emerge in the second half of the financial year. Many Indian banks, particularly in the public sector, are not well capitalised. As they factor in bad loans, their capital will erode and crimp their ability to lend. Banks' focus is now to keep their capital healthy and tide over uncertain times. Those that do not get capital, will have to show their true health, writes Tamal Bandyopadhyay.

Tamal Bandyopadhyay
4th August

IDBI Bank Ltd and Uco Bank did an encore in the June quarter. IDBI Bank posted a Rs 144.43 crore net profit, after recording a Rs 139 crore net profit in the March quarter. Before that, it had posted losses close to Rs 42,000 crore for 13 successive quarters. For Uco Bank, the June quarter net profit is Rs 21.45 crore: after it had made an even smaller, Rs 17 crore, net profit in March quarter. The Kolkata-headquartered bank took 17 quarters and over Rs 16,000 crore loss up its chin to come back to the black.

The State Bank of India has put up a stellar show. Its net profit in the June quarter has been Rs4,189 crore, 81 per cent higher than the year-ago quarter. Of course, one-off gains of Rs 1,540 crore on account of stake sale in its life insurance arm contributed to this. Private lender ICICI Bank Ltd too recorded a handsome 36 per cent rise in its net profit at Rs 2,599 crore, fetching gains from selling stakes in both its life and non-life insurance companies.

The rise in HDFC Bank Ltd’s net profit has been 19.6 per cent but many private banks, including Axis Bank Ltd, IndusInd Bank Ltd, Bandhan Bank Ltd, Yes Bank Ltd and Kotak Mahindra Bank Ltd, have recorded a drop in their June quarter net profit. The quantum of drop varies between 67.8 per cent (IndusInd Bank) and 8.5 per cent (Kotak Mahindra Bank).

So, how do we read the tealeaves for Indian banking?

'When the tide goes out'

Sometime in late 1992, after Hurricane Andrew--a powerful and destructive Atlantic hurricane--struck the Bahamas, Florida, and Louisiana and exposed the frailty of the US insurance industry, Warren Buffet made a famous comment: “It’s only when the tide goes out that you learn who’s been swimming naked.”

He said this to describe what had already happened: the insurance industry masking its adventurism and being exposed after the good times ended. I’m tempted to rephrase his quote and say, “It’s only when the moratorium is lifted, we will learn which banks are healthy and which are not.”

Barring a few, banks saw a drop in their non-performing assets (NPAs) in the June quarter. They have made hefty provisions, anticipating deterioration in the quality of assets. Will that protect their balance sheets? It all depends on how economic activities pick up and borrowers who have availed of the banks’ offer for moratorium on repaying loans behave.

In the wake of the coronavirus pandemic, the Reserve Bank of India (RBI) announced a six-month moratorium for all term loans. The moratorium was given for March-May and then extended to August. There has been clamour for extending the facility, as most businesses battle lockdowns across India to contain the coronavirus pandemic. There could be pressure on banks’ retail loan books, as many people who borrowed for homes or cars have lost their jobs or accepted sharp pay cuts.

Finance minister Nirmala Sitharman said last week the government and the RBI are discussing the scope for restructuring loans and extending the moratorium.

A bad loan deluge?

Views vary. Most bankers, given a choice, would not want the moratorium extended and, instead, avoid giving loans to industries most affected in the slump: aviation, travel and tourism, and construction to list a few. Some bankers feels the moratorium should continue in top cities across India till normalcy returns.

Particularly for small finance banks, there is a clear line dividing rural and urban borrowers. Few borrowers have sought moratorium in rural India and the repayment graph is on the rise, but it’s not a happy scene in urban pockets. Small businesses in cities are struggling and some borrowers have shut shop and left for villages.

There is another view: instead of a blanket or even industry-specific extension, the moratorium should be offered to affected retail and industrial borrowers. In other words, banks should be free to restructure their stressed loans.

As we wait for the RBI’s decision, there is no clarity on how deep will be the impact of the coronavirus pandemic on banks’ balance sheets. Bankers claim loan repayments are rising, but a true picture will emerge in the second half of the current financial year, if the moratorium ends in August.

The banks follow the so-called accrual accounting, a method where revenue or expenses are recorded when a transaction occurs rather than when the payment is received or made. This means, they have been booking interest and only a quarter after the moratorium ends if a borrower is not able to service the debt, the particular account will turn bad.

Before the pandemic, experts felt the worst was behind the Indian banking industry. The aggressive bad loan recognisition phase, which started in September 2015 with the RBI’s asset quality review, was about to end and recovery looked near. The insolvency law has not been a great success story, but bankers used it to bring rogue borrowers to the discussion table and recover bad loans outside the ambit of the insolvency and bankruptcy framework. As banks gave bulk of the bad loans, such recoveries added to their bottomline.

Accounting for NPAs

Gross NPAs, which rose to 12.5 per cent in March 2018, dropped to 9.7 per cent a year later; further 9.3 per cent in September 2019 and 8.5 per cent in March 2020. The coronavirus has changed the scene dramatically. The graph will reverse and the gross NPAs could spike to 14.7 percent of bank loans by March 2021, the RBI's latest Financial Stability Report (FSR)--a biannual health check--says. That’s the worst-case scenario. A more conservative estimate puts the gross NPA figure next March at 12.5 per cent.

If indeed, Indian banks’ gross NPAs rise to 14.7 per cent by March 2021, it will be a 22-year high. The last time banks had a worse higher gross NPAs was in 1999: 15.9 per cent. That dropped to 14 per cent in 2000 and single-digit 9.4 per cent in 2003.

Government-owned banks are worse off than their private sector peers. Their gross bad loan ratio could increase to 15.2 per cent by March under the baseline scenario, the FSR says. That has always been the pattern. Almost immediately after the introduction of income recognition norms, the gross NPAs of the banking industry turned out to be 19.07 per cent in 1994. For public sector banks, NPAs were 24.8 per cent.

The problem is that many Indian banks, particularly in the public sector, are not well capitalised. As they factor in bad loans, their capital will erode and crimp their ability to lend. The capital-to risk-weighted assets ratio of Indian banks will drop from 14.6 per cent in March 2020 to 13.3 per cent in March 2021 under the baseline scenario and to 11.8 per cent under the very severe stress scenario, the FSR says. “Stress test results indicate that five banks may fail to meet the minimum capital level by March 2021 in a very severe stress scenario,” it says.

It’s given that banks won’t get rid of the rise in bad loans. Their focus now to keep their capital healthy and tide over uncertain times. Private banks have already raised capital or in the process of raising it. The government is yet to announce a plan to infuse capital in public sector banks. The Union Budge did not made any provision for it.

Those that do not get the capital will be swimming naked when the wave of moratorium recedes.

(The writer, a consulting editor with Business Standard, is an author and senior adviser to Jana Small Finance Bank Ltd.)

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A few links for further reading

Are Indian banks out of the woods?

Earnings season is over at most Indian banks. Looking at the September-quarter results, one might be tempted to say the worst is behind for the India banking industry. Many banks have surpassed analysts’ profit estimates; even if a few have announced losses or smaller profits, that’s primarily on account of one-off deferred tax asset adjustments. Three government-owned banks and one owned by Life Insurance Corp continue to be in a bad shape. At least 10 public-sector banks are busy with their consolidation plans. Is Indian banking out of the woods? The answer will have to wait, writes Tamal Bandyopadhyay.

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