Decoded: What are pro forma NPAs and how does that impact borrowers?

The financial results season is on. Listed Indian banks have been presenting two sets of numbers on asset quality. One, presented by adhering to the rule book as well as an apex court ruling. The other shows numbers, on prudential basis, termed as pro forma figures assuming the absence of the court ruling that bars treating defaulting loans as non-performing assets (NPAs). The latter reveals a much clearer picture about the pain or stress on books.

What are pro forma NPAs? And why are they being disclosed as distinct from those shown in the income statement of banks?

Lenders are presenting asset quality profile by sticking to the rule that asks for accounts with 90-day overdue to be treated as NPAs as a prudent step. This is despite the Supreme Court of India’s interim stay on classifying such accounts (with 90-day overdue) as NPAs.  

In September 2020, the Supreme Court barred banks from declaring any loan account as NPA until further orders, giving relief to individual and commercial borrowers. The court gave this interim stay while hearing petitions that questioned the charging of interest on loans during the six-month moratorium on repayments that ended on August 31, 2020.

In the income statement for the second quarter (September 2020) and third quarter (December 2020), banks have shown NPAs in line with the Supreme Court directive. Banks give pro forma basis figures in notes to income statement. An analysis of results declared by listed banks so far shows that the NPA figures shown in the bank income statements are lower than the ones earmarked on pro forma basis.

How does that impact borrowers? Can lenders begin face recovery proceedings? Does the borrower get further credit assistance?

The assessment is done at portfolio level on the basis of borrower behaviour. So, borrower accounts are not being tagged as defaulters. Hence, the credit score of customers is not impacted till now. Those facing genuine difficulties in repayment will still be eligible for assistance like additional credit and restructuring to soften the blow and to be able to recover.

What is the character of pro forma NPAs?

This pool also covers some loans that are being restructured under regulatory dispensation to give relief to borrowers (retail, small and medium-sized enterprises, or SMEs, and corporate) hit by the pandemic. Bankers say the pro forma slippages have a substantial chunk from the retail and SME segment. It is for the first time that banks are dealing with higher level of retail slippage due to job loss and, in some instances, closure of businesses.

The corporate loan portfolio has been stress tested for many years now, and lenders have taken steps to restructure, resolve and make recoveries. So, this time around, the share of corporate loans in the stress pool is expected to be limited.  

How is it being seen by the market and rating agencies?

Such disclosures and accompanying provisions are seen as proactive and prudent steps to fortify the balance sheets in some way for the impending asset quality deterioration due to the pandemic-induced economic disruption. The Reserve Bank of India’s Financial Stability Report has estimated that gross bad loans of banks in India would rise from 7.5 per cent in September 2020 to 13.5 per cent by September 2021 under the baseline scenario. The pain could be higher with gross non-performing assets (GNPAs) of 14.8 per cent in September 2021 under severe stress scenario.

Are non-banking financial companies, including those giving home loans, impacted? How do they treat this?

Finance companies are also impacted by the Supreme Court judgement, but there is a difference. They follow new accounting standing standards (Ind-As) that require an assessment of expected defaults and not just clear overdues. They account for probable loan slippage portfolio (often called expected credit loss) and make a provision factoring in such assessment. In this sense, the process has an element of being proactive.