Economic battle in a health emergency

Let me begin with a most significant statement by the International Monetary Fund (IMF) chief Kristalina Georgieva that the world economy is facing “severe” economic damage from the coronavirus pandemic that could be even more costly than in 2009.

He has warned finance ministers from the Group of 20 nations that the outlook for 2020 “is negative – a recession at least as bad as during the global financial crisis or worse.

The IMF chief said all countries need to work together to protect people and limit the economic damage, which so far seems out of bounds for the global leaders in their respective fields.

Notably, the global economy had contracted by 0.6 percent in 2009 as a result of the 2008 global financial crisis. At that time major emerging markets like China and India were growing at a rapid rate.

Today, the situation is totally different, The coronavirus pandemic is causing worldwide economic and human carnage, and some forecasters now say the downturn could be 1.5 percent.

So, in this fearful scenario when the effects of the COVID-19 pandemic continue to reverberate; financial system across the globe is already shaking like a jelly.

As the pandemic continues to leave the authorities clueless, the financial system is going to face very serious challenges to remain afloat in the days to come.

In this situation, financial institutions like banks stand pushed to the wall as they have been the immediate causality of this human consuming outbreak, and aftermath of the pandemic is even going to be the worst scenario ever faced by banks.

There is not even a single economic sector in India which has not been hit by the pandemic. Small and Medium Entreprises (SMEs), airlines, hotels, tour operators, restaurants, retail trade stand exposed to get a major hit as demand steeply falling in these sectors.

Auto consumer durables, construction and real estate too are in negative zone as here also the demand seems nowhere in sight.

The slowdown of demand in various sectors of economy means that banks would be witnessing tremendous stress in their loan portfolios, which ultimately can lead to a crash of their loan books. Precisely, surge in non-performing assets (NPAs) would be inevitable and most complications would arise that the recovery of bad loans would almost become impossible for a longer period in the given mayhem.

A rough numerical estimate in the backdrop of damage caused to the country’s banking industry shows that in the worst case scenario of macro-economic slowdown, bad loans may surge 120 basis points with private sector banks facing maximum risk.

A stress test conducted by the RBI prior to the outbreak of the virus showed that overall bad loans could rise to 10.5 percent of total loans in September 2020 from 9.3 percent in September last in the worse-case scenario of `severe stress.’ In case of`medium stress,’ it could climb to 10.2 percent, forecast from the Financial Stability Report released in December shows.

Under the severe stress scenario, the RBI’s financial stability report said the gross NPA of public sector banking group may rise to 13.5 percent from 12.7 per cent. As things stand now, the lock down, which seems to be prolonged for over a month, is surely going to throw the economy out of gear.

We should be shocked to witness large scale job losses and pay cuts in the coming times and such measures would be on long term basis. Here again, it would be another disaster for the banks as it will dent not only their retail loan growth, but will lead to higher default.

The RBI’s response to such developments will hold the key. In the first instance, the rules and regulations governing the banking operations particularly in loan segment need to be relaxed or a part of such rules kept aside till situations turns to pre-coronavirus pandemic condition.

For example, a relaxation in 90 days default norms before declaring them as NPAs would give relief to both the industry and the banks.

The industry would continue to enjoy credit facility while the banks will not be required to make any NPA provisioning from their profits.

Globally speaking, European Central Bank (ECB) has reduced the capital buffer requirement for banks to allow them to lend more in the coronavirus-affected times.

Chinese Central Bank has provided refinancing support to Covid-19 impacted sectors as well as lower lending rates for small businesses. Central Bank of Australia, the Philippines Central Bank and many others are relaxing rules for banking sector to help the industry.

Back home, the total exposure of banks to Covid-19 hit sectors such as hospitality, tourism, trade, transportation, aviation and Micro, small and medium enterprises (MSMEs)  is reported to be in excess of Rs 11 lakh crore.

As per RBI’s sectoral data, the loan outstanding against the trade (import and export industries) is the highest at Rs 5.19 lakh crore followed by MSMEs, where the outstanding loans are Rs 4.73 lakh crore. Transports operators owe Rs 1.41 lakh crore, and tourism, hotel and restaurants (Rs 45,394 crore).

The current NPA at over 9.1 per cent ( Rs 9.36 lakh crore ) of total advances are already at an alarming level. In fact, the NPA provisioning pressure and the subsequent delay in resolution of these assets has been putting capital pressure on banks.

So, what banks immediately need is the capital for provisioning as well as growth if the banks are to be allowed to remain afloat. This time relaxing the NPA asset classification norms for select sectors won’t help.  

Precisely, the impact on the banks and financial institutions would be more dreadful ever witnessed by the financial sector and the central bank (RBI) has to move out of the traditional routes and roll out tailor-made solutions to avert what Moody’s call ‘economic tsunami’.

From a credit perspective, the regulator should quickly take measures to identify most affected sectors to understand how it can be most supportive to plagued economy.

At the same time, the banks should be encouraged to get proactively engaged with clients to understand their situation, segmenting portfolios based on expected needs, developing an internal view of where support measures will be the most effective, and adjusting risk-mitigation actions for early delinquencies and for nonperforming exposures. Supporting clients in these critical times will deepen customer relationships.

There would be people in distress who have been rendered jobless. The stress will be especially acute for those who are already in debt. These individuals will likely need further support from banks to support day-to-day liquidity needs through credit.

Among businesses, the impact will vary significantly by sector and by company. It seems quite likely at this point that travel and tourism, entertainment, automotive, oil and gas, and healthcare industries will be most affected due to disruptions in supply and demand.

Within these sectors, smaller businesses, such as those that cannot shift to remote work and online delivery and those catering to the most vulnerable segments, are likely to be more affected.

Meanwhile, focused programmes aimed at the MSME sector are imperative. The regulator should consider easier lending policies, lower interest rates, deferred taxes and fees and additional funds for MSMEs to help them stay in business to the extent possible and above take extraordinary measures to ensure job security to the workers already employed.

In succinct, the regulators and the government have to understand the challenge and offer out of box, rather out of way support to the banks. This way we can fight the economic battle unleashed by the health emergency created by coronavirus pandemic.

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