RBI's Financial Stability Report: A bag of surprises

Reserve Bank of India's Financial Stability Report is an eagerly awaited report to gauge the health of the banking system in particular and the likely stress situation. The readings from the report are encouraging just like the downward movement of the Covid curve in the country. Contrary to all expectations of NPAs increasing due to the pandemic, the report reveals that they were pretty much under control at 7.5% in March 2021. This should come as a relief to the market as earlier conjectures were in the region of 12-15%. 

The other encouraging revelation is that the stress tests indicate that under normal conditions the NPA ratio will increase to 9.8% by March 2022 while the two stress scenarios could push it to 10.4% and 11.2%, respectively. But the stress scenarios look very unlikely as they involve GDP growth slumping to 6.5% or less than 1%. Therefore, one can be confident of the quality of assets being firm even though a flag has been raised by the RBI on the migration in SMA quality. Significantly, in terms of restructured assets, the ratio is just 0.9%, which is low and surprising. Surprising because it was felt that the one-time restructuring exercise that was adopted would have led to several companies exercising this option, which is not the case.

Credit should go to the RBI and banks for managing the situation. The plan of giving moratorium during tough times and rolling back the same has helped to keep things under check. The same holds for classification of NPAs where we are back to normal. Banks too have not gone overboard in lending despite all the schemes, which has actually made NPA ratios in all sectors, except retail, to decline. The slippage ratio which is NPAs on incremental loans is low at 2.5% which gives credit to the banks. Similarly, the coverage ratio at 68.9% has also ensured that banks were progressive here, which has maintained sanity against any future shocks. In a way it can be said to be a true team effort in containing the situation. The lessons of the past has definitely helped banks to be more cautious.

The sectors of concern for NPAs- CGEM (construction, gems and jewelry, engineering and mining) have over 15% ratio while metals, infra, power, textiles, food etc. are in double digits. Chemicals and auto have done well with 5-7% range. Retail is minor concern even though the ratio is low at 2.1% as it should not become a part of the ‘culture’ of not repaying. Hopefully, this is temporary as last year was tough for individuals who were out of jobs and income to service their debt.  

An interesting aspect pointed out in the report is that the RBI has actually ensured that the investment valuation did not cause disruption for banks. Normally when there are large investments made in a market where the government borrowed Rs 12.8 trillion, yields should have gone up thus pushing prices down. However, by carefully managing the yield curve with various operations like GSAP and OMOs, banks have been protected against a valuation decline.  This is also indicative of the fact that in 2021-22, the picture will be replicated as the yields have been kept down, which means that banks can be comfortable with the investment portfolio. 

Last, even the profit ratios look good with NIM at 3.3% and return on assets too in the positive territory. One thing that stands out is that the cost of funds was 4.7% while yield on assets was 7.6% - quite clearly the deposit holder bore the brunt as 2.9% spread looks high by any standard.

The author is Chief Economist, CARE Ratings and author of: Hits & Misses: The Indian Banking Story. Views are personal.