RBI's stand on IL&FS exposure spells trouble for banks, NBFCs

Firms that provided for exposure on a voluntary basis may now have to mark the same as NPAs

In an explanation to the ongoing dispute on whether or not loan exposures to stressed infrastructure major IL&FS are to be classified as non-performing assets (NPA), the Reserve Bank of India (RBI) clarified to the National Company Law Appellate Tribunal or NCLAT that it is the obligation of banks to mark any loan as such after a default of 90 days. Banks cannot be relieved of their obligations to classify bad loans in their account books, the RBI added.

While this is a part of the RBI’s argument in the ongoing litigation, for banks and non-banking finance companies (NBFCs), its implication could be pronounced. For one, these financial entities have been providing for their exposures in IL&FS from the September 2018 quarter voluntarily and more out of prudence, albeit lower than what regulations would have required. That’s because the account, according to most lenders, remained ‘standard’ till December 2018 quarter.

However, the RBI’s assertion on the matter could change the narrative. “Until the December quarter, banks had not recognised their exposure to IL&FS group as NPA. Now they will have to,” says Kajal Gandhi of ICICI Securities. This, in turn, means an imminent increase in provisioning costs and a consequent drag on the financials of banks and NBFCs.

Since the extent of provisioning may not be uniform across the system, analysts say the March quarter (Q4) may witness a spike in provisioning costs for some of these entities, over and above what was already factored in. Moreover, the analysts add that the trouble from the IL&FS loans may even extend beyond Q4.

According to Siddharth Purohit of SMC Capital, not all banks will be impacted the same way. “IndusInd Bank has made adequate provisioning for the holding company exposure of Rs 1,000 crore, though provisioning may increase on loans to subsidiary companies,” he adds. As for public sector banks, with exposure higher to subsidiary companies, analysts expect a steeper increase in provisioning costs for them. Among NBFCs, L&T Finance with Rs 1,800 crore has the highest exposure to IL&FS group. HDFC too has about Rs 450 crore of exposure to the infrastructure major.

In short, while the extent of pain could vary, it stretches the road to recovery for banks, especially government-owned and compounds the earnings pressure for NBFCs.