2 min read.Updated: 21 Jun 2020, 08:24 PM ISTVivek Kaul
Both corporate, individual defaults are expected to increase in the months to come. However, these bad loans will not start piling immediately. Mint explains why.
Covid-19 will lead to an increase in default of loans taken from banks and non-banking financial companies. Both corporate and individual defaults are expected to increase in the months to come. However, these bad loans will not start piling immediately. Mint explains why.
As Stephanie Kelton writes in The Deficit Myth, “Spending is the lifeblood of capitalism. Without it, businesses would have no customers, no sales revenue, and no profits to keep them afloat." Consumer spending has collapsed over the last few months due to the pandemic. Though lately there have been some signs of revival, it will take a while before spending comes anywhere near the pre-covid level. This will mean that many businesses will start running out of cash pretty soon if they have not already. A company that starts running out of cash will not be in a position to repay its loans and, thus, will ultimately default.
Where do individuals fit in this scenario?
A recent estimate by rating agency Crisil suggests that about 70% of 40,000 companies have cash to cover employee costs for only two quarters. This tells us that companies will fire employees, before, during, or even after defaulting on a loan. If companies do not resort to employee retrenchment, they will cut salaries and many already have. Past payments and future business with vendors and suppliers will be negatively impacted. In this situation, the problem at the company level will impact individuals too. When individuals start having a cash flow problem, it will lead to defaults on retail loans
Why aren’t we seeing loan defaults spiking already?
The Reserve Bank of India has let banks and non-banking financial companies (NBFCs) offer a moratorium on loans. Hence, until the end of August, borrowers have an option to not repay the loans, without it being considered as a default. A moratorium is a deferment of repayment to provide temporary relief to borrowers. The loan ultimately needs to be repaid.
Analysts at Macquarie Research pointed out in a research note that at present as much as 20-30% of the loans from banks are under a moratorium. They expect that by the end of August when the moratorium ends, about 50% of the loans from banks could be under a moratorium. Hence, any loan defaults will start only after August but they won’t be immediately categorized as a non-performing asset or a bad loan. Bad loans are largely those loans that have not been repaid for 90 days or more.
When will loan defaults be deemed bad loans?
A loan has to be in default for 90 days to be categorized as a bad loan. Hence, defaulted loans will be categorized as bad loans only post-November and this will be revealed when banks publish their results for October to December 2020, in January-February 2021. Even if 20% of loans that end up under a moratorium are defaulted on, the quantum of bad loans, especially those of public sector banks, will go up big time.
Vivek Kaul is the author of Bad Money.
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