The Reserve Bank of India’s (RBI’s) Financial Stability Report (FSR) of December 2020 has stated that banks’ gross non-performing assets (GNPAs) may rise sharply to 13.5 per cent by September 2021, and escalate to 14.8 per cent, nearly double the 7.5 per cent in the same period of 2019-20, under the severe stress scenario.
And banks will have to brace for a rollback of regulatory forbearance that was announced in the wake of the pandemic, and enhance their capital positions.
The FSR, released on Monday, gave a caveat: “Considering the uncertainty regarding the unfolding economic outlook, and the extent to which regulatory dispensation under restructuring is utilised, the projected ratios are susceptible to change in a nonlinear fashion”.
This suggests that the RBI’s forbearance measures may not be giving an accurate picture on the stress currently.
In his foreword, RBI Governor Shaktikanta Das noted: “Stretched valuations of financial assets pose risks to financial stability. Banks and financial intermediaries need to be cognisant of these risks and spillovers in an interconnected financial system.”
The growing disconnect between certain segments of financial markets and real sector activity, pointed out in the last FSR (June 2020), has got further accentuated, with abundant liquidity spurring a quest for returns. Within the financial market spectrum too, the divergence in expectations in the equity market and the debt market has grown.
State-run banks are seen being the worst-affected among bank groups with their GNPA ratio expected to increase to 16.2 per cent by September 2021 under the baseline scenario from 9.7 per cent in September 2020. And to a high of 17.6 per cent in a severe stress scenario.
The implications for capital adequacy (cap-ad) are as follows. Systemic cap-ad is projected to drop to 14 per cent in September 2021 from 15.6 per cent in September 2020 under the baseline scenario and to 12.5 per cent under the severe stress scenario.
The FSR mentioned that “stress test results indicate that four banks may fail to meet the minimum capital level by September 2021 under the baseline scenario, without factoring in any capital infusion by stakeholders. In the severe stress scenario, the number of banks failing to meet the minimum capital level may rise to nine”.
The FSR has also made a tweak.
In the last FSR, a one-time additional scenario of “very severe stress” was introduced in view of the uncertainty around the pandemic, its economic costs, and delay in the data-gathering process. With a better appraisal of the pandemic’s impact on economic conditions, it is assessed that the worst is behind us, though the recovery path remains uncertain. Accordingly, stress tests have reverted to the regular 3-scenario analysis in this issue.
The FSR does not explicitly refer to recapitalisation, but noted the pandemic threatened to result in balance sheet impairment and capital shortfalls, especially as regulatory reliefs are rolled back.
“In addition, banks will be called to meet the funding requirements of the economy as it traces a revival from the pandemic,” Das added in his foreword.
This basically is a reiteration of the RBI’s position in its Report on Trend and Progress of Banking in India (2019-20), which said “the modest GNPA ratio of 7.5 per cent at end-September 2020 veils the strong undercurrent of slippage”.
The accretion to NPAs in accordance with the RBI’s income recognition and asset classification norms would have been higher in the absence of the asset quality standstill provided as a pandemic relief measure. And that given the uncertainty induced by the pandemic and its real economic impact, the asset quality of the banking system may deteriorate sharply.
The FSR hinted the Centre might have to fast-track the recapitalisation concerns of state-run banks without referring to the subject directly.
“Banks have sufficient capital at the aggregate level even in the severe stress scenario but, at the individual bank level, several banks may fall below the regulatory minimum if stress aggravates to the severe scenario.”
With the stress tests pointing to deterioration in the asset quality of banks, an early identification of impairment and aggressive capitalisation are imperative for supporting credit growth across various sectors, alongside pre-emptive strategies for dealing with potential NPAs. Dividend earning from state-run banks is uncertain because the RBI has said that banks are not to make any dividend payment on equity shares from the profits pertaining to the financial year ended March 31, 2020, so that they can support lending.
Banks need to prepare for these adversities by augmenting their capital base.
While easy financial conditions are intended to support growth prospects they can have unintended consequences like encouraging leverage, inflating asset prices and fuelling threats to financial stability, the report said.
As for non-banking financial companies (NBFCs), credit given by NBFCs grew by a mere 4.4 per cent as compared with 22 per cent in 2018-19. Gross NPAs of NBFCs increased to 6.3 per cent on March 2020 from 5.3 per on March 2019. Asset quality is expected to deteriorate due to disruption in business operations caused by the pandemic, especially in the industrial sector, one of the major recipients of NBFC credit.