Another startling statistic came to light on Friday that highlights the weak lending practices of India’s banking sector: wilful defaulters owe more than 64,000 crore to state-owned banks, almost one-fifth of the total bad debt of the banking system.

Remember, banks have written off at least a trillion rupees of bad debt over the past four years as well.

In his last monetary policy speech, Reserve Bank of India (RBI) governor Raghuram Rajan expressed the hope that banks would clean up their balance sheets by March 2017. The Hindu newspaper recently reported that RBI is going to increase its scrutiny of banks’ financial accounts to achieve this deadline.

RBI’s move and the wilful default statistic highlight one thing: the biggest worry now is whether all the stressed assets have been recognized or are more skeletons going to come tumbling from the closet. Not everyone believes that the full extent of the problem has been recognized.

Nomura Research, for instance, estimates that the banking industry is sitting on around 5-6 trillion of stressed assets. The brokerage further says that the loss resulting from default on these assets could be as much as 1.7 trillion. Put another way, these 6 trillion of assets are as high as three-fourths of the current stock of stressed assets (declared non-performing assets, or NPA, plus restructured assets) in the system.

What are the repercussions on banks’ balance sheets and profitability? Assuming that future loss in the event of default is 20% of the fiscal 2015 net worth of banks and adding provisioning on NPAs and restructured book, by March 2017—the governor’s deadline—the total impact could be as high as 50% for state-owned banks, says Nomura.

Similarly, factoring in credit costs to recognize this increased stress and a concomitant impact on net interest income, both spread over the next three fiscals, returns on equity (RoE) could fall by as much as 10 percentage points for state-owned banks. Nomura estimates even private lenders such as Axis Bank and Yes Bank could see RoEs decrease 2-3 percentage points if the scenario materializes. Since state-owned bank RoEs are already low, further stress would make it more difficult for them to meet Basel III capital adequacy norms.

Only an accelerated economic recovery and boost to investment demand, which will enable companies to service debt, will solve the bad debt problem.

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