Bad Debt Could Reach 9.8% At Indian Lenders: RBI Draft Report
Indian banks to brace for another wave of stress as bad loans could hit 9.8% of their loan portfolio by year-end, up from 7.5% in FY21 , a draft version of the Reserve Bank of India (RBI) Financial Stability Report (FSR). ) mentionned. The second wave of the pandemic is expected to have negatively impacted the income outlook for borrowers, both businesses and individuals.
“As the impact of the second wave kicks in and regulatory abstentions are lifted, banks face the risk of emerging asset quality issues materializing,” the report said. Mint saw a copy of the report.
However, unlike in the past, lenders will not lack capital to deal with this stress. Banks’ risk-weighted asset ratio could decline slightly to 15.5% by March 2022 as a baseline scenario, from 15.8% in March this year. In the worst-case scenario, where severe strains translate into bad debts reaching 11.2% of total loans, banks could find capital adequacy ratios to drop to 13.3%. All of these results on capital are above the minimum regulatory requirement of 11.5% which includes 2.5% of the capital conservation buffer. The stress tests assume 9.5% growth in gross domestic product (GDP), average retail price inflation of 5.1%, and measures for four other macroeconomic data for various scenarios.
Admittedly, the increase in bad debts predicted by the stress test is well below the forecasts of the previous report published in January. At that time, the RBI predicted that the bad debt ratio would rise to 13.5% by September. It should also be noted that the RBI stress tests have overestimated toxic credits in recent years (see graph).
The draft report indicated that distressed loans would come mainly from micro, small and medium enterprises (MSMEs) and retail borrowers. These categories were the biggest beneficiaries of forbearance, such as the moratorium, restructuring and the status quo on asset recognition. In addition, public sector lenders have been at the forefront of small business lending, in addition to aggressively seeking retail credit in recent years. As a result, most of the stress could appear on the balance sheets of public sector banks, with gross bad debt ratios likely to reach 12.5% by March.
Signs of stress among MSMEs have appeared in bank lending on Special Mention Accounts (SMA). These capture the first 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 increased to 11.8% in FY21 from 8.6% in FY20. in the private sector, this ratio fell from 2.6% to 3.2%. In addition, it should be noted that credit flows to struggling MSMEs from the government’s credit guarantee program were substantial during the year. On Monday, the government increased the plan’s spending by ₹1,500 billion.
In the personal loan portfolio, data from the credit bureaus shows that more than a quarter of loans slipped into the riskiest subprime category in January compared to the period a year earlier. In essence, the perception of credit risk has deteriorated for retail borrowers. “All lenders except PSBs have started to experience increased stress, which is particularly acute for unsecured loan products,” the report notes.
The advantage for banks is that large borrowers may not be the main source of stress, although their share may remain high. Potential collections from old defaults, a low pool of restructured loans, and a likely resumption of credit growth can help banks reduce their pool of toxic loans. As such, banks have made provisions against covid risks in fiscal year 21. “Banks have already made provisions for contingencies against much of the stress of the pandemic. These contingency provisions could be drawn this year. The need for additional provisioning is lower now, ”said Anand Dama, analyst at Emkay Global Financial Services Ltd. Coupled with the capital increase in fiscal year 21, banks should emerge stronger despite the pandemic. Analysts have improved profit estimates for large banks, anticipating an improvement in their overall profitability in FY22. Dama believes that large bad debt collections can also help banks improve profitability.
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