Even though the Reserve Bank of India (RBI) expects economic activity to recover to last year’s levels in the second half of the current financial year, and growth to pick up in the first half of next year, its latest financial stability report lays out in no uncertain terms the formidable challenges facing the banking system as it deals with the fallout of the pandemic. Even though gross non-performing assets (GNPAs) have been on a decline, and banks had built relatively sound capital buffers, the problem, in part, is that the true extent of the bad loans in the system is unknown due to the regulatory forbearance provided to cushion the blow of the pandemic. But with the withdrawal of these regulatory relief measures, the underlying stress in the system will surface. And as RBI governor Shaktikanta Das notes, banks are likely to witness “balance sheet impairments” and “capital shortfalls”. This is a grim prognosis.
The RBI has carried out a series of tests to gauge the extent of stress in banks’ balance sheets under various economic situations. In its baseline scenario, banks’ bad loans could rise to 13.5 per cent by September 2021, up from 7.5 per cent at the end of September 2020. In case the economic situation worsens, bad loans could rise even further to 14.8 per cent. One indication of the build up in stress is already evident: Large borrowers in the SMA-0 category (loans which are overdue for 1-30 days) have grown by a staggering 245.6 per cent over March 2020, signalling possible slippages in the coming quarters.
There may be a desire to kick the can down the road — to relax the NPA recognition norms and mask the true extent of the bad loans. That would be a mistake. Addressing the balance sheet stress in the economy requires focusing on what the Economic Survey has called the 4 Rs — recognition of bad loans, recapitalisation of banks, resolution for stressed firms and reforms to alter the incentive structures. However, considering that trillions spent on bank recapitalisation have not yielded justifiable returns, and the opportunity costs of such large allocations, especially for a cash strapped government, there are legitimate questions to be asked over the recapitalisation of public sector banks by the government. Questions must also be asked about whether outright privatisation is even possible or is shifting to a structure like the Bank Investment Company more appropriate. The government needs to think through the various alternatives, and clearly articulate its vision for the banking sector in the upcoming budget.