The recent order of the Supreme Court regarding classification of NPAs and payment of compound interest for the period of moratorium has reignited a debate on the state of Indian financial sector. The order of Supreme Court has been received by markets as a relief, as it removes a regulatory overhang and paves way for the banks to proceed with recovery of NPAs. Nonetheless, the next few quarters need to be watched closely for any precipitous rise in bad loans; especially if the recovery appears faltering.
Past few years have been quite challenging for Indian financial
services sector. A decade of massive infrastructure building exercise
(1998-2008) resulted in significant advancement of demand and therefore
unviable projects in key sectors like housing, roads, power, civil aviation,
metal & mining, SEZs, Ports etc. resulted in a multitude of stalled and
unviable projects. Administrative and regulatory irregularities in allotment of
natural resources to private parties led to judicial action, compounding the
problem of failed projects. Demonetization (2016) and implementation of
nationwide uniform Goods and Services Tax (GST, 2018) led to permeation of
stress of MSME sector, especially the unorganized sector. The lockdown induced
by Covid-19 pandemic (2020) further exacerbated the stress in this sector.
The process of recognition of the stress in sectors like
infrastructure, metal & mining, telecom etc. started with changes in rules
in 2014 & 2015. However, the real impetus was provided by implementation of
Insolvency and Bankruptcy Code in 2017. The process started in right earnest
with identification of top 12 (dirty dozen, 2017) non performing accounts by
RBI and initiation of resolution process under IBC. Closer scrutiny of large
stressed accounts resulted in collateral damage in terms of exposing of frauds
and fraudulent lending at some NBFCs (IL&FS & DHLF) and Banks (Yes
Bank, PNB, PMC etc.)
In past 4years, the process of NPA recognition and resolution
accelerated; though not at the desirable speed. This entire process has
resulted in emergence of some key trends in financial markets:
·
Many weak banks have been identified. Some in
public sector of these have been merged with relatively stronger banks. Some in
private or cooperative sector have gone under rehabilitation (including
management change) process.
·
Most banks have resorted to raising fresh
capital to strengthen their capital adequacy. The government has also provided
fresh capital to stronger banks.
·
Couple of large non banking financial companies
(IL&FS and DHFL) have faced action under IBC. This resulted in massive
losses to mutual funds who had been a major lenders to these companies. This
has resulted in tightening of funding of NBFCs by mutual funds.
·
The restructuring of perpetual bonds (AT-1) of
Yes Bank, triggered a rethink on the risk profile of this important source of
capital for banks; thus narrowing the window of raising capital for banks.
·
In view of the elevated stress level, most banks
have materially tightened the credit assessment standards. This has resulted in
sustained slow-down in credit growth, especially to low rated companies and
MSMEs.
·
To manage the rise in deposits, due to fiscal
& monetary stimulus and lower consumption during stressed times, many banks
have resorted to increased emphasis on high margin personal loans. This trend
threatens to put incremental stress on bank’s finances if the recovery falters
due to relapse of pandemic or otherwise.
As per the latest Financial Stability Report (RBI, January
2021):
·
Macro-stress tests for credit risk show that
SCBs’ GNPA ratio may increase from 7.5 per cent in September 2020 to 13.5 per
cent by September 2021 under the baseline scenario. If the macroeconomic
environment deteriorates, the ratio may escalate to 14.8 per cent under the
severe stress scenario.
·
Stress tests also indicate that SCBs have
sufficient capital at the aggregate level even in the severe stress scenario
but, at the individual bank level, several banks may fall below the regulatory
minimum if stress aggravates to the severe scenario.
·
The overall provision coverage ratio (PCR)
improved substantially to 72.4 per cent from 66.2 per cent over this period.
These improvements were aided significantly by regulatory dispensations
extended in response to the COVID-19 pandemic.
·
At the aggregate level, the CRAR of scheduled
urban co-operative banks (SUCBs) deteriorated from 9.70 per cent to 9.24 per
cent between March 2020 and September 2020. NBFCs’ credit grew at a tepid pace
of 4.4 per cent on an annual (Y-o-Y) basis as compared with the growth of 22
per cent a year ago.
·
In the latest systemic risk survey (SRS), respondents
rated institutional risks, which comprise asset quality deterioration,
additional capital requirements, level of credit growth and cyber risk, among
others, as ‘high’.
As per the rating agency ICRA’s estimates, gross NPA worth Rs
1.3 lakh crore and net NPA worth Rs 1 lakh crore were not recognized as of
December 31, 2020 due to Supreme Court interim order. These NPA may get
recognized in 4QFY21. A recent note ICRA mentioned,
“In ICRA’s outlook for the banking sector for FY2022, we had
estimated the Tier I capital requirements for PSBs at Rs. 43,000 crore for
FY2022, of which Rs. 23,000 crore is on account of call options falling due on
the AT-I bonds of PSBs while the balance is estimated as equity.
“In the Union Budget for FY2022, the Government of India (GoI)
has already announced an allocation of Rs. 20,000 crore as equity capital for
the recapitalisation of PSBs. If the market for AT-I bonds remains dislocated
for a longer period for the reasons discussed earlier, and the PSBs are unable
to replace the existing AT-Is with fresh issuances, this would mean that the
PSBs could stare at a capital shortfall based on the budgeted capital.
ICRA also expects that the GoI will provide requisite support to
the PSBs to meet the regulatory capital requirements, which means that the
recapitalisation burden on the GoI could increase, or the PSBs could curtail
credit growth amid uncertainty on the capital availability. Apart from Tier I,
as mentioned earlier, there could be reduced appetite from mutual funds along
with a rise in the cost of issuing Tier II bonds as the limited headroom for
incremental investments in Basel III instruments.”
In my view, the theme to play in financial sector may be
“consolidation” and “market share gain” by the larger entities (banks and
NBFCs) rather than economic recovery and credit growth. Attractively valued
smaller entities may be vulnerable to extinction.
