Bracing for a burden of bad loans

The economy shrank by nearly one-fourth during the first three months of this fiscal year. Much of this was due to the harsh lockdown initiated in March. Roughly three-fourths of the economy was practically shut down for at least a month, after which there were a series of renewed lockdowns, with partial relaxations. For this
quarter, the economy suffered a triple shock, as demand, supply and
finance collapsed. Unemployment rose close to 30 per cent in April,
rendering nearly 122 million people jobless. In cities, whose
workforce consists of 40 per cent migrants on an average, the toll on
livelihoods was severe. With loss of jobs and income, it soon became a food crisis for many urban households, necessitating emergency
measures from state governments. The Central government’s initial
relief package was to enhance food security, by doubling the rations
and extending them to November.

The big Rs 20 lakh crore package announced by the Central government in May consisted largely of liquidity support. For instance, micro, small and medium enterprises are eligible for guaranteed loans up to Rs 3 lakh crore. Of this amount, roughly half the amount has been sanctioned and loans are being disbursed. It is no wonder that the demand for loans is muted, since small businesses already hit by zero demand, are not keen to take on additional debt burden. But those small businesses which have a cash management mismatch, i.e. they have pending invoices which have not been paid by their customers, are quite willing to take loan support to tide over their crisis. In effect, such small businesses face problem of illiquidity, not of insolvency.

The situation is similar for all sectors of the economy. The
Reserve Bank of India has injected liquidity worth nearly Rs 8 lakh crore cumulatively. This is a combination of interest rate cuts, buying up of government bonds from banks (an operation called 'open market operations') and buying foreign exchange and releasing cash. The RBI has also given low-cost long-term funds to commercial banks, as well as non-bank finance companies. This is called a long-term repo operation.
Much of this excess liquidity i.e. cash availability has not resulted
in loan growth, but instead, probably gone into the stock market. The inflow of foreign funds, plus excess liquidity in Indian banking is one reason that the stock market has recovered by more than 50 per cent, since the steep fall in March. To some extent we have recovered from at least one of the three shocks in the triple shock, i.e. the financial shock.

While the GDP shrinks and supply and demand challenges remain, the second quarter GDP may show some improvement. But the growth numbers will still be negative. More than half the households as per a survey, are reporting that their income this year will be lower than last year.

Businesses too are struggling to catch up to pre-Covid revenues. In
such a situation, the bank credit to industry will be highly stressed.
The bi-annual financial stability report of the RBI had already warned
in its July report that the non-performing assets (NPA) ratio could rise a full 4 percentage points, from March 2020 to March 2021. That is nearly a write-off of Rs 4 lakh crore of bank loans. If there were a ‘severely stressed scenario’, the NPA ratio could be two per cent higher, at 14.7 per cent, which means a write-off of an additional Rs 2 lakh crore.

The banks’ risk adjusted capital ratio is adequate to meet these write-offs in the aggregate. Under severe stress, this required capital buffer ratio could decline all the way to 9.4 percent, which is not enough, as per Basel norms. With rising bad loans, the banks can make profit and give a decent return to depositors and shareholders by charging a profitable interest rate on the good quality loans. Hence, despite rate cuts by the RBI, the banks are unable to pass on lower interest costs to “good” borrowers, since the burden of NPAs is rising.

To add to these woes of banks is the loan moratorium. To tide over the severe stress caused by the pandemic, the RBI announced a three-month moratorium on ‘good’ loans starting from March. This moratorium was then extended by another three months to the end of August. As of this writing, the moratorium matter is in the Supreme Court, and has been effectively extended till September 28, the date of the next hearing.

The issue is that borrowers want an interest waiver, as well as a
waiver on interest on interest, caused by the delay in repayments. It
seems unfair to load this burden on bank depositors and shareholders.
If indeed the borrowers deserve relief, then it should be given as
explicit fiscal relief, i.e. from the Central government’s treasury.
but such a partial waiver to borrowers who opted for the moratorium and not others who did not, is also problematic.

The larger issue is what is to be done about banking health in times of the pandemic. The RBI-constituted K V Kamath Committee has submitted a report identifying 26 sectors to which loans will need to be restructured, so that they are not counted as NPAs. The committee has carefully identified sectors affected directly by the pandemic, which hence need relief. But those that were already doing badly pre-pandemic need to be dealt with differently. Nearly 72 per cent of the banking sector debt has been affected by Covid and will need some restructuring. The recommendations are based on clearly defined parameters and banks have been split into mild, moderate and severely stressed.

Meanwhile, data from August shows that industrial credit demand is not increasing. In fact, in the first quarter, the demand for 13 out of 19 major industry groups had negative growth as per a CARE Ratings report. The other six were barely positive or zero. Banks need healthy growth in credit demand to remain viable, if not profitable. Most public sector banks will need a large infusion of equity from the treasury of the Central government, especially on account of rising bad loans. There is simply no easy way to dodge this fiscal bullet.

The writer is an economist and Senior Fellow, Takshashila Institution

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