More headwinds for Indian banks as bad loans mount amid pandemic

Debt on the books of Indian banks are set to soar, as companies and individual borrowers hit hard by the Covid-19 pandemic continue steadily to default on loans.

Signs of progress on reducing the worryingly-high degrees of bad loans created before the pandemic hit Asia's third-largest economy already are eroding, pushing the country's financial sector right into a precarious position.

“The non-performing assets situation will probably deteriorate over another year," says Ajit Mishra, vice president of research at Religare Broking in New Delhi. Lenders have limited funding capacity and "that could make the problem worse for banks which could bring about a credit squeeze”, he adds.

The Reserve Bank of India in its financial stability report on Monday said non-performing assets (NPAs) at Indian banks could almost double to 14.8 per cent by September this season under its "severe stress scenario", up from 7.5 % reported in September 2020. The report by the banking regulator projected that even in a "better case scenario", they could rise to 13.5 % this year.

If the problem prevailed until March next year, it could unfold the worst financial scenario since 1999 for Indian banking and financial services companies.

“The financial services industry plays a pivotal role in enabling growth of overall economy and all the sectors,” says Dnyanesh Pandit, managing director of financial services at Protiviti, several independent consulting firms.

“The NPA numbers will be [affected] with the impact of the Covid-19 lockdown as the power of borrowers, generally, to ensure timely payments has undoubtedly been affected.”

The burden of debt has plagued Indian lenders for a long time. Before the pandemic, however, there have been signs of improvement as authorities and lenders took steps to lessen the ratio of non-performing loans and tidy up banks' balance sheets.

“India's banking sector was already fighting high NPAs and the non-banking financial sector was also going right through its credit crisis,” says Rajani Sinha, chief economist and national director at Knight Frank India. “In 2019, we saw things nearly improving for India's financial sector, and in 2020 we got hit by the Covid crisis.”

The RBI's bleak forecast comes despite indications that the country's economy is picking right up amid easing of Covid-19 restrictions. The united states entered into recession in 2020 as the coronavirus pandemic spread rapidly across India, making it the next worst-affected nation globally behind the US.

New Delhi has struggled to bring the virus in order, despite imposing one among the world's strictest nationwide lockdowns that shuttered businesses and put millions out work. At the peak of the lockdown, in the April to June quarter, GDP growth plunged a record 23.9 per cent on an gross annual basis, official figures show.

Although the economy has bounced back from those lows and several economists expect the country to emerge from recession this season, banks are set to feel a number of the lasting effects of the pandemic, experts warn.

“The pandemic threatens to cause balance sheet impairments and capital shortfalls, especially as regulatory reliefs are rolled back,” Shaktikanta Das, the RBI governor, wrote in the financial stability report. “In addition, banks will be called to meet up the funding requirements of the economy as it traces a revival from the pandemic.”

Ms Sinha says that “among the big challenges for India will be rising debt in the organization sector, particularly in the tiny and medium[-sized] business segment” .

She explains that the impact of the pandemic on lenders will probably worsen this season because temporary relief measures rolled out in 2020 by the banking regulator - including financing moratorium and debt restructuring plan - were essentially just a case of “kicking the can later on”.

Some banking specialists say lenders' predicament could easily get a whole lot worse than what the RBI is forecasting.

“As these projections are simply just indicative and the RBI being bullish about recovery of the Indian economy, it may not be surprising that people end up with an even worse situation for the banking sector from a bad loans perspective,” says Gaurav Dayal, a partner at Indian corporate law firm Lakshmikumaran & Sridharan.

Rising stress among Indian banks would also have a knock-on negative influence on the country's economy.

“We can visit a contraction throughout the market [again] because of the rise in bad loans,” Mr Dayal explains.

The rise in bad loans will drastically slice the lending power of the banks, which will have "a deep and long-lasting effect on the economy".

Fitch Ratings has also echoed these concerns in a written report released on Thursday.

The ratings agency said carrying out a sharp rebound of 11 % GDP growth in the coming financial year that commences in April, India will dsicover its economy growing typically at 6.5 % in subsequent four financial years. It cited the lasting ramifications of the pandemic and the “weak state of the financial sector” among the reason why for slower monetary growth.

“Constrained credit supply amid a fragile economic climate is another headwind for investment,” Fitch says.

“The banking sector entered the crisis with generally weak asset quality and limited capital buffers. Appetite for lending will be subdued, particularly as credit-guarantee and forbearance measures rolled out in the crisis learn to be unwound.”

Mr Dayal says the pandemic has pushed the banking sector to a tipping point. Lakshmi Vilas Bank, among India's smaller lenders, which had struggled even prior to the Covid-19 crisis, collapsed in November as NPAs climbed.

“In the current scenario, even small [amounts of] bad loans could prove to be extremely difficult for the smaller banks,” says Mr Dayal. “If appropriate [support] measures aren't taken to reduced the strain, one can expect similar scenes [unfolding] in the Indian banking sector this season [as well].”

Although the government and RBI took taken steps to shore up liquidity and the stability of the economic climate, financial experts say they need to do more, given the extraordinary situation lenders in the united states are facing in the wake of the pandemic.

This consists of recapitalisation of banks.

“More steps and measures will be required especially for public sector banks from the government and RBI until the situation normalises,” says Mr Mishra. “This may be with regards to relaxing certain regulatory norms temporarily and infusion of capital to make sure stability and propel growth.”

The RBI has said it expects banks' overall capital ratio to weaken to 14 % in September in comparison to 15.6 per cent a year earlier.

In its extreme stress scenario, the ratio may fall further to 12.5 per cent. Such a scenario means that as many as nine banks in India could neglect to meet the minimum capital dependence on 9 per cent, in line with the RBI.

The central bank didn't specify which lenders will probably breach its minimum capital requirements, but analysts say that India's public sector banks are most at risk. Private banks are more adequately funded, compared to smaller private and public sector lenders, according to Mr Mishra.

“It'll be a challenge for public sector banks to improve capital from the equity markets in the near term, given their past growth and NPA challenges," says Suman Chowdhury, chief analytical officer at Acuité Ratings & Research. “We believe the larger private sector banks are in an improved position to mobilise capital and that is demonstrated before few years.”

He says the federal government can do everything possible to aid state-run lenders and it has recently set aside funds to provide satisfactory capital to stressed finance institutions.

“The federal government will support the general public sector banks in maintaining their regulatory capital levels,” says Mr Chowdhury. “They'll also explore dilution of stake in a few public sector banks to facilitate fresh capital mobilisation. There is also a proposal to set up a bank holding company in the general public sector. However, the success of the measures remains to be observed.”

He is also upbeat about prospects of Indian lenders and says a quick economical bounce back means banks might not maintain as bad a position as much are forecasting.

“The bad loan trajectory over the medium term will be dependent on the extent of the economical revival in India over the next few quarters,” says Mr Chowdhury.