RBI Financial Stability Report: Bank Bad Loans Could Rise To 13.5% By September

Bad loans of Indian banking system could jump sharply by September, according to Reserve Bank of India's estimates, considering the current macroeconomic climate.

Gross bad loans on bank balance sheets could rise to 13.5% by Sept. 30, the regulator said in its latest edition of the Financial Stability Report. That compares with 7.5% in September 2019.

In the worst case scenario, the gross bad loans could rise to 14.8%—the highest in two decades—by the end of the second quarter of financial year 2021-2022.

According to the RBI's assessment, gross NPAs have been consistently falling over the last two years, with the number at 7.5% in July-September 2020. Even the slippage ratio, the rate of accretion of fresh bad loans, has come down to 0.15% as of September.

“The improvement was aided significantly by the regulatory dispensations extended in response to the Covid-19 pandemic,” the RBI said in the report.

Public sector banks could see the highest 650-basis-point increase in their gross NPAs even under the baseline scenario. Gross NPAs for government-owned banks are estimated to rise from 9.7% in July-September 2020 to 16.2% in July-September 2021, under the baseline scenario, the RBI said. Private banks will likely see their gross bad loans rise from 4.6% to 7.9%.

In its stress test for the banking system, the regulator considered three scenarios for the gross domestic product growth: 0% growth in the second half of FY21 as baseline scenario; -2.1% as medium stress and -7.6% as severe stress. The baseline is derived from the steady state forecasted values of key macroeconomic variables and indicates the central path, the regulator said.

“By design, the adverse scenarios used in the macro stress tests are stringent conservative assessments under hypothetical adverse economic conditions,” the RBI said. “It's emphasised that model outcomes do not amount to forecasts.”

The RBI also introduced a caveat in its stress test for bank asset quality in the report: the projections are indicative of a possible economic impairment latent in bank portfolios, with implication for capital planning.

“...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,” the RBI said.

Among the broad sectors, asset quality improved noticeably in the case of industry, agriculture and services in September 2020 over March 2020, with a decline in gross NPA and stressed advances ratios, the RBI said. In the case of retail advances, however, the gross NPA ratio declined only marginally and stressed advances remained flat.

As per the RBI's assessment the share of large borrowers in the aggregate bank credit and gross NPA of the system fell to 50.5% and 73.5%, respectively. The share of restructured standard advances increased, indicating that large borrowers have commenced availing restructuring benefits extended for Covid-19, the regulator noted.

Even among the top 100 borrowers, the asset quality trends have been positive for the banking system. However, the top 100 borrowers saw a sharp jump in their loans falling into the special mention account category. In the SMA-0 bucket, where repayments are late by less than 30 days from due date, the top 100 borrowers saw a 155.6% rise quarter-on-quarter, as of Sept. 30, indicating higher chances of slippages in the following quarters.

Implications On Capital Adequacy

The system level capital adequacy ratio is projected to drop from 15.6% in September 2020 to 14% in September 2021, under the baseline scenario and to 12.5% under the severe stress scenario, the RBI said.

The stress test results indicate 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, nine banks may not meet the regulatory minimum.

The common equity tier I capital ratio of scheduled commercial banks may decline from 12.4% in September 2020 to 10.8% under the baseline scenario and to 9.7% under the severe stress scenario in September 2021. Under the baseline scenario, two banks may not be able to meet the regulatory minimum of 5.5% CET-1 ratio, while five banks won't meet the bar under severe stress.

While overall, the banking system's capital base maybe able to withstand the stress coming from the Covid-19 pandemic, some individual banks may need support through phase wise capital infusion or other strategic measures, the RBI said.