Editorial

Red flag

| Updated on January 13, 2021 Published on January 13, 2021

The Centre must take pre-emptive steps to avoid the possibly perilous situation on NPAs

Lending institutions will need to play a key role in sustaining the ongoing economic recovery by bankrolling consumer spending, financing private investments and funding the expanded Government borrowing programme. That’s why the RBI’s Financial Stability Report, which contains the central bank’s prognosis for the financial system and stress-tests lenders’ vulnerability to macro risks, assumes significance. The report sees an ‘uneven multi-speed’ economic recovery taking hold and notes that the risk appetite is returning among consumers and businesses. It flags weak credit growth and excessive global liquidity inflating financial assets as speed-bumps. It also observes that the Supreme Court’s standstill on bad loan recognition could be obscuring the build-up of delinquencies at India Inc, with a high proportion of overdue loans as on August 31, 2020, slipping further by November. This is a warning that far from extending regulatory forbearance on recognition of non-performing assets (NPAs) or tinkering with their definition now, the Centre and the Court need to normalise these metrics quickly, so that timely interventions can be made to salvage borrowers and shore up banks.

On the lenders’ financial position, the report starts off innocuously by noting that scheduled commercial banks were on an improving trajectory between March and September 2020, with gross and net NPAs moderating to 7.5 per cent and 2.1 per cent, provision coverage rising to 72.4 per cent and capital adequacy at 15.8 per cent. But stress-testing these numbers for future shocks on macro-variables such as growth, external balance and inflation, it finds that all these metrics can deteriorate sharply in the event of risks surfacing. The RBI’s scenario-analysis finds that gross NPAs for commercial banks can shoot up from 7.5 per cent in September 2020 to 13.5 per cent by September 2021 in a baseline stress scenario, and even to 14.8 per cent in the worst-case scenario of very severe stress. GNPAs of this order would be alarming and would undo much of the painstaking balance sheet repair that domestic banks have managed in the last five years. The silver lining is that the RBI doesn’t expect banks as a class to breach capital adequacy norms even with severe stress. It however finds that nine banks may face challenges in the worst-case scenario. The Centre must focus on pre-emptive capital infusion into public sector banks that seem most vulnerable, based on this study.

The Centre must introspect why public sector banks (GNPAs pegged at 17.6 per cent in severe stress) tend to fare much worse than private sector banks (8.8 per cent) or even NBFCs (8.4 per cent) when put to test; this argues for governance reforms at the earliest. The RBI’s past stress tests have been known to under-estimate the impact on lenders during extreme events. The Centre would therefore do well to heed the warnings in this report and not dismiss it as an academic exercise.

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Published on January 13, 2021
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