RBI Financial Stability Report: Bank NPAs Could Rise To Highest In 20 Years

The Reserve Bank of India has conducted a stress test to gauge coronavirus’ impact on the banking sector’s bad loans.

A cyclist rides along an empty street past the Reserve Bank of India (RBI) headquarters during a lockdown imposed due to the coronavirus in Mumbai, India. (Photographer: Dhiraj Singh/Bloomberg)
A cyclist rides along an empty street past the Reserve Bank of India (RBI) headquarters during a lockdown imposed due to the coronavirus in Mumbai, India. (Photographer: Dhiraj Singh/Bloomberg)

A stress test conducted by the Reserve Bank of India suggests that the Covid-19 crisis could push Indian banks’ gross bad loans to their highest in nearly two decades.

Pressures from the pandemic and the national lockdown are likely to significantly push up bad loans for the banking sector, according to the RBI’s Financial Stability Report for July 2020.

In a “very severe stressed scenario”, the gross non-performing assets of the banking sector could rise to as high as 14.7% of total loans by March 2021, the RBI FSR stated. Under the baseline scenario, the gross NPA ratio could rise to 12.5%, the RBI’s stress test covering 53 scheduled commercial banks showed. As of March 2020, the ratio stood at 8.5% of total advances.

Standard & Poor's, in its June 30 report, had estimated that bank gross NPAs could rise to as high as 13-14%. This, according to data available with the RBI, would be the highest since 12.7% gross NPA ratio reported March 2000.

The results of the RBI stress tests show that public sector banks could see their gross NPAs rise to 15.2% by March 2021 from 11.3% a year earlier in the baseline scenario. In the "very severe stress" scenario, this could go as high as 16.3%.

Private banks and foreign banks would also see a spike in their bad loans because of the worsening macroeconomic factors.

According to the conditions mentioned by the central bank in the stress test, the gross domestic product could contract 4.4% under the baseline scenario. In the “very severe stressed” case, the contraction could be as high as 8.9%.

The banking industry would also see erosion of capital as banks would be required to provide more against defaulters. Under the baseline scenario, system-level capital adequacy ratio could drop to 13.3% by March 2021 from 14.6% at the end of financial year 2019-20.

In case of very severe stress, the capital adequacy could drop to as low as 11.8%, the RBI said in the FSR.

“Stress test results indicate that five banks may fail to meet the minimum capital level by March 2021 in a very severe stress scenario. This, however, does not take into account the mergers or any further recapitalisation, which will further increase systemic resilience,” the RBI said, without naming the banks.

The common equity tier I or CET 1 capital ratio of the banking system may decline from 11.7% in March 2020 to 10.7% under the baseline scenario, and to 9.4% under the worst case by March 2021.

While the regulatory moratorium may be holding back some stress, the industry-wise composition of good quality loans of public and private banks reveals that some of the industries with higher share of such loans across bank groups are severely affected by the Covid-19 pandemic, the RBI said. The regulator describes good quality loans as those which are standard and have not yet seen instances of default.

The sectors with the highest share of “good quality loans”, which might get affected, include general purpose loans by non-banking finance companies, generation of electricity, NBFCs in the housing sector and development financial institutions.

How The Stress Test Works

According to the structure of the test, the RBI considered four possible scenarios with worsening macroeconomic indicators:

  • Baseline Scenario
  • Medium Stress
  • Severe Stress
  • Very Severe Stress