Opinion Banks have fared better than expected in pandemic, but there are also signs of stress building up

Going by the Reserve Bank of India’s Report on Trends and Progress of Banking in India, 2020-21, released on Tuesday, the Indian banking system appears to have weathered the Covid storm better than was expected. The asset quality of banks has improved over the past year or so, and on various other financial metrics too, both public and private sector banks are faring better than before. However, there is cause for concern. Even with the economy recovering to its pre-pandemic levels, the threat of Omicron notwithstanding, the report points out that banks must remain “vigilant of the evolving risks”. In fact, according to the RBI’s financial stability report released on Wednesday, banks may well witness a rise in bad loans over the coming year. Moreover, the withdrawal of monetary and fiscal measures means that banks will need to “further bolster their capital positions to absorb potential slippages as well as to sustain the credit flow.”

At the aggregate level, banks’ gross non-performing assets (GNPAs), which had begun to decline before the pandemic, have continued their downward trajectory. Bad loans stood at 7.3 per cent at the end of March 2021, down from 8.2 per cent in the previous year. Gross NPAs had earlier peaked at 11.5 per cent in March 2018. Provisional data suggests a further moderation this year — bad loans are estimated to have declined further to 6.9 per cent at the end of September 2021. However, this improvement is not only due to lower slippages, but is predominantly due to write-offs (banks wrote off Rs 2.08 lakh crore of bad loans), and policy measures taken by the central bank to lessen the fallout from the pandemic such as the asset classification standstill. In fact, according to the data presented in the report, recoveries from loans that have soured through all channels — Lok Adalats, debt recovery tribunals, the SARFAESI Act, and the IBC — have actually declined from 22 per cent (of the total amount involved) in 2019-20 to 14.1 per cent in 2020-21.

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On other financial indicators, banks have seen an improvement over the past year — capital buffers are up, as are provision coverage ratios. However, there are signs of stress building up. Loans that are classified as SMA-2 (special mention accounts where the principal or the interest payment was overdue for 61-90 days) have risen, signalling impending stress. Stress is also building up in the MSME category. Bad loans may in fact take a turn for the worse in the months ahead. As per the financial stability report, GNPAs could rise to 8.1 per cent by September 2022 under the baseline scenario. If the economic outlook worsens, they may rise further to 9.5 per cent. Banks may thus need “higher capital infusion” to meet credit requirements and deal with the challenges. After all, how quickly credit flows through parts of the economy will have a bearing on the recovery.

This editorial first appeared in the print edition on December 30, 2021 under the title ‘Risk and flow’.