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Collection rates, which improved sharply in the second quarter to an average 95%, may also wan. Photo: Pradeep Gaur/Mint
Collection rates, which improved sharply in the second quarter to an average 95%, may also wan. Photo: Pradeep Gaur/Mint

Forbearance masking bad loans emanating from covid-19 distress, says S&P

  • While financial institutions performed better-than-expected in Q2, much of this is due to the six-month loan moratorium, as well as Supreme Court order barring banks from classifying any borrower as non-performing, the report said

Mumbai: The forbearance on asset classification is masking bad loans arising out of the covid-19 distress and such toxic assets are expected to rise to 10-11% of total loans as relaxations are phased out, S&P Global Ratings said on Tuesday.

“India financial institutions will likely have trouble maintaining momentum after the amount of new non-performing loans (NPL) declined in the first half to 30 September 2020," it said, adding that the banking sector's bad loans will shoot up to 10-11% of total loans as on 31 March 2022, from 8% on 30 June 2020.

The report said while financial institutions performed better-than-expected in the second quarter, much of this is due to the six-month loan moratorium, as well as Supreme Court ruling barring banks from classifying any borrower as non-performing. For banks, their non-performing assets (NPAs) would have generally been higher by 10-60 basis points (bps), in the absence of the court ruling.

The Supreme Court order that allowed banks to maintain certain loan accounts as standard despite defaults by borrowers has at least for now concealed soured loans worth over 26,000 crore, data compiled by Mint showed.

In fact, collection rates, which improved sharply in the second quarter to an average 95%, may also wane, S&P said.

“This trend is aided by the pickup in economic activity since lockdowns ended and, in many cases, by the financial savings of the borrowers. Given that overall economic activity levels remain soft, savings could deplete fast, potentially hurting future collections," it said.

According to the rating agency, since RBI has allowed a one-time restructuring of loans, slippages could decline in the current fiscal year, but it may delay recognition to the next year or so. However, the demand for restructuring so far has been lukewarm, but more requests are expected to flow in December.

“While India is not extending moratoriums, as some other banking jurisdictions have, the RBI is allowing banks to restructure loans with borrowers hit by covid-19. We do not see restructuring as a panacea to all the banking sector problems," it said.

The report pointed out that India has a poor track record of restructuring loans and rampant restructuring in financial years 2012-2015 led to slow recognition and protracted weak asset quality cycle for Indian banks.

“We estimate that more than half of our estimated restructured book may eventually slip into NPLs, leading to elevated NPL and credit cost levels in subsequent fiscal years," S&P said.

That apart, S&P said it expects state-owned banks to be able to absorb estimated credit losses without breaching the regulatory minimums. However, since these banks are generally less capitalised than private-sector peers, and need capital to grow, they need 30,000-40,000 crore of capital in next 12-18 months to support credit growth.

“The government has announced an 20,000 billion capital infusion into the public sector banks; and we believe there is very high likelihood of a bigger infusion, if needed," it said.

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