Banking. Stable, for now

The Reserve Bank of India’s Financial Stability Reports (FSRs) make for dismal reading as they usually find that banks are under imminent stress, if not already stressed. But the latest edition of FSR for June 2021 strikes a positive note, suggesting that banks have emerged from the two waves of Covid in better shape than expected. With large borrowers deleveraging, deposits outpacing credit growth and plentiful liquidity from unconventional monetary measures, banks managed to significantly reduce their non-performing asset (NPA) burden and shore up their capital buffers this past year.

Given the stress to business and household incomes during Covid, banks were expected to see a sharp spike in their NPAs after the lifting of the Supreme Court’s standstill on bad loan recognition in March. But banks have not fared too badly, reporting gross NPAs of just 7.5 per cent and net NPAs of 2.4 per cent by March 2021, lower than 8.4 and 2.9 per cent in March 2020. Banks were also circumspect on restructuring loans, curtailing them to less than 1 per cent. For a change, even public sector banks (PSBs) were well-placed on capital, with market-based fund-raising boosting banks’ overall capital adequacy ratio to 16 per cent by March 2021, against the regulatory norm of 9 per cent. In this backdrop, RBI’s stress-testing of commercial banks for macro risks didn’t throw up alarming results. It showed their gross NPAs could rise to 9.8 per cent in a baseline scenario and 11.22 per cent in a severe stress scenario, far lower than expected in the January 2021 FSR. RBI doesn’t expect any of the 46 commercial banks to fall short of capital even under a severe macro-stress scenario. These banks also seemed fairly well-protected from credit concentration, rate and liquidity risks.

These findings are heartening for the Centre, which has picked a good time to cut the apron strings with PSBs by reducing capital infusions and mooting stake sales. But given that FSR findings are based on theoretical modelling, it may be prudent for regulators not to get too complacent. For one, while scheduled commercial banks acquitted themselves well, 30 urban co-operative banks faced liquidity stress and 24 NBFCs faced capital shortfalls under RBI’s severe stress-testing. Two, while banks’ reported NPAs are under check, they are sitting on restructured accounts and ‘special mention accounts’ which could slip. Three, while large corporate borrowers are on good behaviour, stress is building up in retail loans. The FSR flags that 28 per cent of prime retail borrowers slipped into sub-prime this past year. As RBI itself notes, so far, the impact to the financial system from slow growth, the Covid assault and returning inflation have been cushioned by ‘unprecedented’ policy measures. Withdrawing these props without destabilising the financial system is now the policymakers’ primary challenge.

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