Bad loans may soar to a 20-year high: RBI3 min read . Updated: 24 Jul 2020, 11:07 PM IST
Further deterioration in asset quality will put more pressure on lenders who are facing subdued credit demand
Indian banks’ bad loan ratio is expected to climb to the highest level in more than 20 years as a protracted lockdown has severely disrupted business operations and left millions of people jobless, crimping their ability to repay loans.
Non-performing assets may rise 4 percentage points to 12.5% of total advances by March 2021, the highest since the year ended 31 March 2000, under the baseline stress scenario, the Reserve Bank of India said in its semi-annual Financial Stability Report on Friday. The central bank warned that if the economic conditions worsen further, the ratio may soar to 14.7% under the very severely stressed scenario.
A deterioration in asset quality will put further pressure on lenders who are struggling with subdued credit demand amid the coronavirus pandemic and a mountain of bad loans. Banks are preparing for a further worsening of asset quality by raising funds to bolster their capital buffers. The end of a moratorium on loan repayments, aimed at providing relief to businesses and individual borrowers, on 31 August, may see many loan accounts turn non-performing.
The rise in bad loans may further reduce the ability of banks, especially the weak ones, to extend credit, and the government may have to infuse more funds into state-run banks to build stronger buffers that can absorb loan losses.
The RBI cautioned that the impact of the loan moratorium is still evolving and the exact extent of its impact on asset quality is difficult to ascertain accurately.
“As the asset classification in March 2020 could have been influenced by the regulatory moratorium in the face of the covid-19 pandemic, the projections for this exercise are built up using data from June 2011 up to the quarter ended December 2019 (instead of March 2020)," it said.
Among commercial banks, the gross bad loan ratio of state-run banks could increase to 15.2% by March under the baseline scenario, the highest among its peer groups. Indian state-owned banks were just coming out of the last bad loan crisis and cleaning up their books when the coronavirus pandemic struck.
Notably, the bad loan ratio of private banks and foreign banks may increase to 7.3% and 3.9%, respectively, over the same period.
“While the regulatory moratorium may be holding back some stress, the industry-wise composition of good quality loans of public sector and private sector banks reveals that some of the industries with a higher share of such loans across bank groups are severely affected by the covid-19 crisis," it said.
The stress will also have an impact on bank capital, eroding it as the number of delinquent borrowers rise. RBI projected on Friday that the system-level capital adequacy ratio will drop from 14.6% in March 2020 to 13.3% in March under the baseline scenario and to 11.8% under the very severe stress scenario.
“Stress test results indicate that five banks may fail to meet the minimum capital level by March 2021 in a very severe stress scenario. This, however, does not take into account the mergers or any further recapitalization, which will further increase systemic resilience," said RBI.
Having been dependent on the government for capital infusion, public sector banks are now being pushed to raise funds from the markets. The government has not budgeted any capital infusion into these banks for FY20 although it is to be seen if it changes its stance in the face of the pandemic. The private banks, in turn, with lower bad loans have been more successful in raising funds.
According to the central bank, the common equity tier-I (CET 1) capital ratio of banks may decline from 11.7% in March 2020 to 10.7% under the baseline scenario and 9.4% under the very severe stress scenario in March 2021.
“Furthermore, under these conditions, three banks may fail to meet the minimum regulatory CET 1 capital ratio of 5.5% by March 2021," RBI said, without naming them.