The Reserve Bank of India’s (RBI’s) December 2019 Financial Stability Report, a biannual health check for the banking industry, had predicted the gross non-performing assets (NPAs) rising from 9.3 per cent in September 2019 to 9.9 per cent by September 2020. The contributing factors to the rise were a change in the macroeconomic scenario, a marginal increase in slippages and, of course, the denominator effect of declining credit growth. In the financial year 2020 that ended in March, bank credit growth has been 6.1 per cent, less than half of 2019’s 13.3 per cent.
I hate to play the role of a Cassandra but the NPAs of the banking system will surely rise far higher – by September it could be as much as 5 percentage points higher from the current level.
The villain of the piece is Covid-19. The RBI has supplemented the government’s modest fiscal package with a three-month moratorium on all loan repayments by the borrowers between March and May. The idea is to mitigate the burden of debt servicing during the time of stress and disruptions in business.
Whether this is enough will depend on how long the fight continues to contain the pandemic and when normalcy returns. For now, let’s take a look at what will cause the sudden rise in bad loans.
If one had been in default before March, banks are allowed to extend the benefit of the moratorium to such a borrower for the March-May period but the overdues till February will attract the income recognition and asset classification (IRAC) norms.
What is that? When a borrower is not paying the due, the lenders must recognise the “incipient stress” in the loan account. Such accounts are classified as special mention accounts or SMAs. Typically, all loan instalments are paid once a month. For a delay of 1-30 days, the account is called SMA-0; 31-60 days, SMA-1; and 61-90 days, SMA-2.
Such borrowers are “defaulters” but the accounts remain standard till 89 days. It turns into an NPA, if the instalment is not paid for 90 days. There could be some habitual defaulters who take advantage of the system while others may end up delaying servicing their loans because of cash flow problems.
How will those borrowers, who are already under stress and had not paid their loan instalments on time till February 29, pay up after May? If at all, their stress will only rise in the current economic scenario.
Let’s take a look at the universe of such borrowers. Data aggregated from banks, non-banking finance companies, housing finance companies and micro-finance companies with meticulous care show 7.8 million live commercial loan accounts at this point.
Micro loans (up to Rs10 lakh) account for 27 per cent of them; 64 per cent are small loans (Rs10 lakh-Rs10 crore); 4 per cent medium loans (Rs10-50 crore); and 5 per cent are large loans (more than Rs50 crore). Roughly, 7 per cent of these accounts are stressed.
Now, look at their value and how much of it is stressed. Here, the classification of categories is a bit different. There is no change in micro and large loan definitions but small loans, for this purpose, are Rs10-15 crore; and medium, Rs15-50 crore.
In value terms, of the Rs88,000 crore micro loans, Rs19,000 crore or 21.59 per cent is stressed. In small loans, out of Rs12.35 trillion, Rs40,000 crore or 3.24 per cent is stressed. Of the Rs4.51 trillion medium loans, Rs15,000 crore or 3.33 per cent is stressed. The least stress is in the large loans – 2.57 per cent or Rs1.2 trillion, out of Rs46.72 trillion.
Overall, Rs1.94 trillion or 3.01 per cent of the commercial loans is showing “incipient stress”.
Let’s focus on the retail loans — mortgages, auto and two-wheeler loans, loans to buy consumer durables, personal loans, education loans, credit cards, et al. Over the past few years, the amount of consumer loans, personal loans and credit cards have been swelling, signaling rise in consumption.
There are 236 million such live loans and 14.8 million of them are stressed. The value of the entire retail portfolio in the system is Rs53 trillion and the stress is far more than the commercial loans — Rs4.1 trillion or 7.74 per cent.
Overall, the credit kitty of the Indian financial system is Rs117.46 trillion. The RBI data show Rs103.7 trillion bank credit in March 2020 but that captures the loans given by scheduled commercial banks while this pile includes loans of banks as well as all other financial intermediaries. Of the Rs117.46 trillion, Rs6.04 trillion or 5.14 per cent represents stressed assets.
If we assume that all stressed borrowers will not be able to service their accounts in June (for those are in SME-0 category) or, latest by September (SME-2 accounts), the NPAs of the system will rise by 5.14 percentage points.
Does this sound scary? Yes, but it can get even worse. The lockdown has brought economic activities to a halt and we do not know how long will it continue and when we with get to the business-as-usual mode. The stress will intensify and many more borrowers may not be able to pay up. The incidence of cheque bouncing (for those who are not opting for the moratorium) have doubled or even trebled, some lenders say. Typically, many retail borrowers keep post-dated cheques with the lenders for instalment payments.
There will be a double whammy. Banks will have to classify many accounts as bad and provide for them. This will hit their profitability. Some of the NBFCs may even go belly up. The government may have to infuse capital in some of the public sector banks, yet again.
Once a bank classifies an account as NPA, the borrower will not be able to raise funds from any other lender. Essentially, many businesses, particularly in the micro, small and medium segments, will have to close down, leading to millions in job losses.
The only way to save the economy and the financial system seems to be a relaxation of the IRAC norms by the regulator – extending the 90-day schedule to 180 days. The RBI can relax this with a clear road map of returning to the current norm over a period of, say, three to two years in a staggered way – from 180 days to 150 days-120 days-90 days.
If it’s not done, both banks and industry will have nightmares, beginning September.