Toxic loans hit 10-yr low; RBI sees even better days ahead

According to RBI’s half-yearly financial stability report (FSR), gross bad loans of banks plummeted to 3.9% of total loans, marking their lowest point since 2013. Additionally, net non-performing assets (NPAs) have also fallen to 1% of total loans—the lowest figure since June 2011. It indicates that banks have been actively setting aside provisions to cover bad loans, RBI added.

“The system-level gross NPAs ratio and net NPAs ratio have sharply fallen from a high of 11.5% and 6.1% in March 2018, respectively…," the report said.

RBI said the improvement in asset quality has been broad-based, with a steady decline in stressed loans ratio across all major sectors. The regulator also cautioned that even as asset quality for personal loans showed an improvement, impairments in credit card receivables have marginally risen.

According to RBI’s stress tests to assess the resilience of banks’ balance sheets to unexpected shocks, the gross NPA ratio of all banks may improve to 3.6% by March 2024 under the baseline scenario. However, if the macroeconomic environment worsens to a medium or severe stress scenario, the ratio is likely to rise to 4.1% and 5.1%, respectively, the report added.

RBI presented a detailed analysis of the impact of increasing loan rates amid rising inflation on different categories of home loan borrowers. Highlighting the fact that high inflation in a rising borrowing cost scenario adversely impacts household finances and its loan repayment capacity, RBI said the twin shocks can put even households with sustainable repayment capacities at risk.

According to data sourced from 20 banks, the central bank found that out of about 2 million home loan accounts, households with monthly income of over ₹1.4 lakh, accounted for more than 40% of the loans. “A noteworthy finding here is that due to the coupling effect of inflation and rate increases, even households with sustainable levels of EMI to income ratio (EIR) are at a risk of having negative margins," it said.

A household’s financial margin refers to its income after deducting estimated taxes, housing loan EMIs, and expenditures on necessities. “Another cause for concern is the significant impact it can have on banks’ capital," it added.

Though the capital-to-risk weighted assets ratio (CRAR) of the sample banks were above the 9% threshold without factoring in inflation and rate hikes, the CRAR of two banks with sizable housing loan portfolios fell below the level, RBI said in the report.

Meanwhile, stress tests showed that banks were well capitalized and capable of absorbing shocks at least for a year, even if further capital is not infused. “Under the baseline scenario, the aggregate capital adequacy of 46 major banks is projected to slip from 17% in March 2023 to 16.1% by March 2024." The central bank said that capital adequacy may go down to 14.7% in a medium stress scenario and to 13.3% under a severe stress scenario by March 2024. But, despite the contraction, it will remain above the minimum capital requirement of 11.5%, including capital conservation buffer.