Banks' bad loans may rise to 12.5% by March 2021: RBI report

Mumbai: Indian banks' bad loan ratio may increase 400 basis points (bps) to 12.5% of assets by March under the baseline stress scenario, the Reserve Bank of India (RBI) said on Friday. This could even rise to 14.7% under the “very severely stressed" scenario, the central bank said in its Financial Stability Report for July.

While the report is usually released in December and June, this year it has been delayed by a month. Bad loan ratio is bad loans expressed as a percentage of total loans and shows the amount of stress on a bank’s books.

RBI cautioned that since the impact of the loan moratorium is still uncertain and evolving, the exact nature of how it will play out on the quality of banking assets is difficult to ascertain. “Therefore, this will only be ascertainable with passage of time, and outcomes would be disseminated in the forthcoming publications of RBI, from time to time," it said.

According to RBI, the resilience of Indian banking in the face of macroeconomic shocks was tested through macro-stress tests which attempt to assess the impact of cumulative shocks on their balance sheet and generate projections of bad loan ratios and capital adequacy rations over a one-year horizon.

“As the asset classification in March 2020 could have been influenced by the regulatory moratorium in the face of the covid-19 pandemic, the projections for this exercise are built up using data from June 2011 up to the quarter ended December 2019 (instead of March 2020)," it said.

Among bank groups, the gross NPA ratio of public sector banks could increase to 15.2% by March under the baseline scenario, the highest among its peers. Indian state-owned banks were just coming out of the last bad loan crisis and cleaning up their books when the coronavirus pandemic struck, throwing earlier projections out of the window.

The bad loan ratio of private banks and foreign banks may increase to 7.3% and 3.9%, respectively, over the same period.

“While the regulatory moratorium may be holding back some stress, the industry-wise composition of good quality loans of public sector and private sector banks reveals that some of the industries with higher share of such loans across bank groups are severely affected by the covid-19 crisis," it said.

The stress will also have an impact on bank capital, eroding it as the number of delinquent borrowers rise. RBI projected on Friday that the system-level capital adequacy ratio will drop from 14.6% in March 2020 to 13.3% in March 2021 under the baseline scenario and to 11.8% under the very severe stress scenario.

“Stress test results indicate that, five banks may fail to meet the minimum capital level by March 2021 in a very severe stress scenario. This, however, does not take into account the mergers or any further recapitalization, which will further increase systemic resilience," said RBI.

Having been dependent on the government for capital infusion, public sector banks are now being pushed to raise funds from the markets. The government has not budgeted any capital infusion into these banks for FY20 although it is to be seen if it changes its stance in the face of the pandemic. The private banks, in turn, with lower bad loans have been more successful in raising funds.

According to the central bank, the common equity Tier I (CET 1) capital ratio of banks may decline from 11.7% in March 2020 to 10.7% under the baseline scenario and to 9.4% under the very severe stress scenario .

“Furthermore, under these conditions, three banks may fail to meet the minimum regulatory CET 1 capital ratio of 5.5% by March 2021," RBI said, without naming individual banks.