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Indian banks will have to set aside more funds to cover soured loans, crimping profits, once the Supreme Court lifts a stay on asset classification, but a swifter-than-expected economic recovery may cushion the blow as more stressed borrowers will be able to repay loans, analysts said.

The top court on 3 September ordered a stay on classifying bad loans if not declared so by 31 August and banks were expected to use this relaxation till the final orders were passed.

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Investors are concerned the delay in recognition of stressed assets will lead to a pile-up of non-performing assets (NPAs), putting pressure on banks’ profits. “We expect asset quality to worsen if the Supreme Court lifts its order that banned banks from marking defaulted loans as NPAs. The slippages could be meaningfully high," a 6 January report by Kotak Institutional Equities said. The report said bad loans have been “artificially suppressed" due to the moratorium between March and August followed by the Supreme Court order since September.

Lenders have, however, claimed that the number of borrowers seeking debt recasts is much lower than they had anticipated. Debt recast numbers and management commentaries of banks after the December quarter earnings announcements may throw light on why borrowers chose to forego easier repayment terms despite the large amount of loans under moratorium. RBI data showed over 40% advances were under moratorium as on 31 August.

“A higher-than-expected slippage this quarter but a positive commentary of the future worries us the most. It raises uncertainty and will result in investors seeking fresh evidence of improvement while a lower slippage and better commentary on growth is probably the best outcome, which appears to be a low probability," the Kotak report said.

Banks have started disclosing the extent of under-reported bad loans in FY20. State-owned Bank of India reported gross non-performing asset (NPA) divergence of 63 crore and total provisions under divergence to be at 930 crore. The bank said it had a shortfall of 394 crore in NPA provisions, 513 crore for standard assets and another 23 crore for investments. However, it has set aside 572 crore in FY21.

Some analysts expect the money already set aside to cover loan losses to be enough to tide over asset quality surprises, if any. Banks have so far created covid-19 specific loan-loss buffers of up to 1.3% of loans, in addition to their existing floating and contingency buffers, Anand Swaminathan, an analyst at BofA Securities, said in a 5 December note.

“Banks are keen to put the profit and loss drag from covid related losses in FY21 and look forward to a cleaner FY22," said Swaminathan.

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