Covid-19 crisis a termite for banks

At a time when plans and strategies by the country’s think tanks are being pooled together to keep the economy not only afloat but also growing, a dazzling cover story  ‘Why Our Banks are Timebombs’ by India Today Magazine in its latest issue is enough to gauge that all is not going well in our banking industry. Basically the deterioration in the health of our banks further paced up when the outbreak of coronavirus brought the economic activity to a grinding halt. As the pandemic-induced lockdown led to job losses and substantial drop in incomes of massive population linked to the banking system, the burden of losing revenue as well as otherwise assured interest income proved inevitable for the banks.

In fact, all evils of the Covid-induced economic emergency-like situation were drifted towards the banking system. Even as government dished out several stimulus packages to bring the economic wheel back on track, its huge cost (including transmission costs) to respective sectors of economy was borne by the banks. Precisely, the burden of Covid crisis too has started consuming the health of our banks and the overall banking system is bleeding, now profusely.

When we talk about health of banks, it’s the strength of financial metrics which gauges the strength of a bank. Actually clinical diagnosis of ailing health of a bank can be picked while examining its non-performing asset (NPA) ratio, capital adequacy ratio, market cap etc.

As all of us understand, non-performing asset ratio tells us about the loans that have remained unpaid and are universally referred as bad loans. Burgeoning non-performing assets (NPA) crisis is always a looming catastrophe which can shake not only the erring banks but also the country’s whole economy. Even as banks in the past one decade were struggling hard to bring the burgeoning NPA level within a comfort zone, the Covid pandemic tore apart all such collective measures and today the banks have been described as ‘time bombs’. It’s worth mentioning that the crisis of non-perming assets can be ignored only at nation’s peril.

What the surge in bad loans means for banks? Simply, the survival of a good number of banks would be at stake. The banking sector in pre-Covid times was already overloaded with huge pile of bad loans. Now, corona-induced bad loans will cripple them and could be a final nail in the coffin of those banks loaded with huge non-performing assets (NPAs).

Even as there is a hint of some sort of revival in economic activities amid the continued Covid-19 crisis, the banks continue to feel the heat, especially when EMI moratorium has ended. When all stakeholders including the regulator (Reserve Bank of India), government and even the Supreme Court of India currently stand locked on the issue, it’s the banking community which visualizes that all is not going to be well with their loan portfolios. In this situation they have a genuine reason to fear an unprecedented surge in bad loans.

Here it makes a sense to reproduce a report by India Ratings and Research (Ind-Ra) about the impact of the pandemic on banks. According to the report,which I have quoted in the past also, Covid-19 and the associated policy response is likely to result in an additional Rs 1,67,000 crore of debt from the top 500 debt-heavy private sector borrowers turning delinquent between FY21 and FY22. This is over and above the Rs 2,54,000 crore anticipated prior to the onset of the pandemic, taking the cumulative quantum to Rs 421,000 crore, the report said.

Given that 11.57 per cent of the outstanding debt is already stressed, the proportion of stressed debt is likely to increase to 18.21 per cent of the outstanding quantum.

The rating agency said in a scenario wherein funding markets continue to exhibit heightened risk aversion, corporate stress could increase further by Rs 1.68 lakh crore, resulting in Rs 5.89 lakh crore of the corporate debt becoming stressed in FY21-FY22. Consequently, 20.84 per cent of the outstanding debt could be under stress in the agency’s stress case scenario.

Meanwhile, we have witnessed an interesting scenario since 2012, when top management of many banks after every increase in their bad loans were regularly giving statements that the ‘worst is over’. But, what actually happened over the period of all these years is that the situation on account of bad loans only worsened and the RBI put restrictions on the operations of some major banks through preventive corrective action (PCA).

Precisely, in pre-Covid times, Indian banking industry was in shambles for the sustained surge in bad loans. Default in loan repayments continued to remain a major concern threatening the existence of some major banks, particularly the public sector banks. The mounting bad loan portfolio of banks refused to drop despite a series of measures by the Reserve Bank of India’s (RBI), to arrest the menace. We can sum up that the regulator simply failed and missed the actual depth of non performing assets of the banks when the problem was in its infancy stage.

Meanwhile, banks are themselves to be blamed for this situation. They didn’t evinced interest in cleaning the mess existing in their asset quality. Most of them resorted to ever greening and delayed recognition of bad loans. For all these years (Pre-Covid times) reports indicated hidden mess behind the declared financial results in most of the so-called ‘strong banks’.

We have to understand that NPAs do not happen overnight. Loans are sanctioned after a thorough appraisal of the proposal and credit worthiness of the borrower. More importantly, after the sanction, there is this duty enjoined on the lender to monitor whether the amount is being utilised for the appropriate purpose. Thus, those who approve the project report carelessly and fail to monitor such loans should ideally also be held responsible for the loans turning into NPAs.

We have also observed that certain changes in the policies of the Government have proved the greatest reasons for creation of bad loans. The borrower is lured by the State and Central governments promising him all kinds of facilities such as land, power, infrastructure, raw materials, subsidies etc. But unfortunately many of these promises are often a mirage, contributing a great deal to the birth of NPAs.

We cannot overlook the fact that “A stitch in time saves nine”. A regular and systematic follow-up of loan portfolio will help the banks to keep the borrowing unit on their alertness and guide them to rectify their mistakes. This would also be a helping hand in tiding over their tight times. Normally, such close follow-up programs are conspicuous by their absence. In the result, the borrowing units ignore payment of their dues to the banks.

Incidents of a borrower turning into a defaulter are not new in the banking industry. But willfully refusing to repay the loan is simply a crime. Banks get deposits from the public and same deposits are granted as loans and advances to the borrowers belonging to various sectors of economy. When these funds change hands, the money gets multiplied. The appreciation in the value of money in the process results in the growth of the individuals, firms, companies and overall in the economy. Any blockade happening in this flow of money cycle hampers growth. Here the willful defaulter is a parasite on the economy. Ironically, most of the willful defaulters have turned out from influential class – those who enjoy access to the corridors of power.

Lastly, let me pick vital content from India Today’s cover story ‘Why our banks are timebombs’. In a report published on October 29, research consultancy Capital Economics issued a dire warning, that India’s banking sector, which had been in poor shape even before the pandemic began and suffered further balance sheet damage from the coronavirus crisis, warrants extreme concern. ‘[India’s banking] sector is entering a slow-burning crisis, where bad debts will eat into profits and restrict lending, holding back recovery [through] the decade’, wrote economists Shilan Shah and Simon MacAdam. They predicted that, relative to its potential, the Indian economy would see one of the weakest recoveries among major economies.

Bad debts constrain a bank’s ability to continue lending: with its assets unable to generate enough income, the bank’s ability to issue further credit diminishes. The whole system has been in gradual decay over the years. The Covid-19 crisis is a termite for banks and has made things worse.

(The views are of the author & not the institution he works for)