Business / Banks' bad loan ratio may rise to 9.8% by March 2022: RBI report

Nwq Delhi: India’s banks should brace for another wave of stress as bad loans may touch 9.8% of their loan book by the end of the fiscal year from 7.5% in FY21, a draft version of the Reserve Bank of India’s (RBI) financial stability report (FSR) said. The second wave of the pandemic is expected to have had an adverse impact on the income prospects of both corporate and individual borrowers.

“As the impact of the second wave plays out and regulatory forbearances are withdrawn, banks face the risk of incipient challenges to asset quality materializing," the report said. Mint has seen a copy of the report.

However, unlike in the past, lenders won’t find themselves lacking in capital to weather this stress. The capital risk-weighted assets ratio of banks may fall marginally to 15.5% by March 2022 as the base-case scenario from 15.8% as of March this year. In the worst-case scenario where severe stress results in bad loans rising to 11.2% of total loans, banks may find capital adequacy ratios drop to 13.3%. All these outcomes on capital are higher than the minimum regulatory requirement of 11.5% that includes 2.5% of capital conservation buffer. The stress tests assume a 9.5% growth in gross domestic product (GDP), a 5.1% average retail inflation and metrics for four other macroeconomic data for various scenarios.

To be sure, the increase in bad loans predicted by the stress test is far below the forecasts of the previous report released in January. At that time, RBI projected the bad loan ratio to surge to 13.5% by September. It should also be noted that RBI’s stress tests have been overestimating toxic loans in recent years (see chart).

The draft report said troubled loans would mainly emerge from micro, small and medium enterprises (MSMEs) and retail borrowers. These categories were the biggest beneficiaries of forbearance, such as moratorium, restructuring and standstill on asset recognition. Further, public sector lenders have been at the forefront of lending to small businesses, besides aggressively chasing retail credit in the past few years. Therefore, the bulk of the stress could appear on balance sheets of public sector banks, with gross bad loan ratios likely to touch 12.5% by March.

Signs of stress among MSMEs have emerged in the special mention account (SMA) loans of banks. These capture early signs of stress by recording how long repayments are overdue. The proportion of SMA 1 and 2 loans in the MSME category for public sector banks shot up to 11.8% in FY21 from 8.6% in FY20. For private sector banks, this ratio has increased to 3.2% from 2.6%. Further, it should be noted that credit flow to stressed MSMEs from the government’s credit guarantee scheme was substantial during the year. On Monday, the government increased the outlay of the scheme by ₹1.5 trillion.

In the retail loan portfolio, data from credit bureaus show more than a quarter of loans slipped to the riskiest subprime category by January from the year-ago period. In essence, credit risk perception has worsened for retail borrowers. “All lenders except PSBs have begun to record increase in stress, which is particularly acute for unsecured lending products," the report notes.

The upside for banks is that large borrowers may not be the main source of stress, although their share may remain high. Potential recoveries from past defaulters, a low restructured loan pile, and a likely pick-up in credit growth may help banks bring down their toxic loan pile. As such, banks have shored up provisions against risks from covid in FY21. “Banks have already made contingency provisioning against much of the stress from the pandemic. These contingency provisions could be drawn down this year. Need for incremental provisioning is lower now," said Anand Dama, an analyst at Emkay Global Financial Services Ltd. Coupled with the increase in capital during FY21, banks are likely to emerge stronger despite the pandemic. Analysts have upgraded the earnings estimates of large banks, anticipating an improvement in their overall profitability in FY22. Dama believes that recoveries from large bad loans may also help banks in improving profitability.