RBI's red flag

Recognition of NPAs in PSBs must be swift

The Reserve Bank of India (RBI) on Monday released its latest Financial Stability Report. In his foreword, RBI Governor Shaktikanta Das was straightforward in warning of the effects of the pandemic: That, in spite of “relatively sound capital and liquidity buffers” built up after the last crisis in 2008, the period of the pandemic might result in “balance sheet impairments and capital shortfalls”. The fine print of the report bears out Mr Das’ concern. There is little doubt that the primary task of the banking sector over the forthcoming year will be to deal with the fallout on already stressed balance sheets of a pandemic that will have caused many projects and borrowers to go under. But the banking sector will also be called upon to return the Indian economy to a growth trajectory through a credit offtake. Thus, the return to growth to a large extent will depend on the timely and efficient management of the banking sector. The government, both as the overall steward of the economy and as the controller of a large proportion of the banking sector, has a great deal on its plate.

The outcome of stress tests conducted by the RBI on banks is one major takeaway of the report. In particular, the tests predicted that, under a baseline scenario, the ratio of gross non-performing assets (GNPAs) would rise to 13.5 per cent in September of this year. This after a period when, following regulatory action and the working of the Insolvency and Bankruptcy Code, the NPA ratios for the sector seemed to have begun to decline. Within the sector, public sector banks would see a GNPA ratio of over 16 per cent in this scenario. These are levels at which, usually, concerns about a banking crisis would dominate discussion. In spite of the other major concerns facing policymakers, therefore, the plight of the banks cannot afford to be ignored.

Part of the problem, as the report implies, is the regulatory forbearance that has been forced by the pandemic. There will be an inevitable spike in NPAs following the end of these measures, as banks make various pending decisions and move assets into the NPA column. The judiciary has not helped matters. In the course of hearing a PIL (public interest litigation) petition — Gajendra Sharma vs Union Bank of India — the Supreme Court has essentially stayed bank NPA levels at the level they were on August 31. Therefore, the actual level of delinquency and stress in the banking sector remains completely unknown — even to bankers. It is far from clear to them what level of provisioning they will need to be prepared for.

In its response to this problem, the government must at all costs avoid kicking the can down the road. It is better to make sure the classification, provision, and resolution process begins work early and finishes swiftly. Some might hope that postponing the recognition of bad loans will allow some to survive the immediate danger of the pandemic. But that is based on little other than hope or wishful thinking. Given that quick recognition and resolution are the key, it is unfortunate that the government — as reported by the newspaper — wants the period for which a loan is not serviced before it is declared an NPA extended from 90 to 120 days. What is required is proactively building up adequate capital, and a quick return to credit growth.