The good and the bad

Fog over bank NPA lifts, but shadow over NBFCs lengthens

Indian banks seem to have finally got a grip on their bad debt problem. The non-performing assets (NPA) cycle peaked in March 2018, thanks to the relentless drive by the Reserve Bank of India (RBI) over the past four years to make banks recognise their hidden bad assets. With most of the stress identified, the NPA cycle has turned around with the gross NPA ratio declining to 9.3 per cent in March 2019, and is expected to fall to 9 per cent in March 2020, according to the RBI’s Financial Stability Report, released on Friday. Public sector banks’ (PSBs’) gross NPA ratio may decline from 12.6 per cent in March 2019 to 12 per cent by March 2020, while private sector banks may witness the ratio improving from 3.7 per cent to 3.2 per cent. The provision coverage ratio (PCR) of all banks rose sharply to 60.6 per cent in March 2019 from 52.4 per cent in September 2018 and 48.3 per cent in March 2018, increasing the resilience of the banking sector.

 
While the first “R” of “recognition, resolution and recovery” seems to have been realised, the harder part remains. The good news is that the Insolvency and Bankruptcy Code (IBC) is a strong regulation though resolution in some cases is still stuck in courts. Under the RBI’s revised prudential framework on stressed assets issued in June 2019, there is a disincentive for banks in delaying to file insolvency applications. Interestingly, a systemic risk survey by the central bank found that half the respondents agreed that the prospects of the Indian banking sector would improve, albeit marginally, in the next one year aided by the stabilisation of the process under the IBC. That would also improve the confidence in the domestic financial system, according to the FSR.

 
However, it is important for banks to realise that they can no longer continue doing business the old way. The FSR also points out that at least five banks would be falling below the regulatory level of minimum capital adequacy by next year if no additional money is infused by the government. In any case, recapitalisation of banks can be only a temporary fix, while the permanent solution would be to merge these weak banks into a larger entity that can be managed better and more efficiently.
 

The bigger problem is the health of the non-banking financial companies (NBFCs). The gross NPA ratio of the sector increased from 5.8 per cent in 2017-18 to 6.6 per cent in 2018-19, while the capital adequacy ratio moderated at 19.3 per cent from 22.8 per cent in March 2018. And on top of that, some of the NBFCs are defaulting or delaying on their payment obligations. According to the RBI’s contagion analysis, should the largest housing finance company fail, it can wipe out 5.8 per cent of the tier-1 capital of the banking system. The RBI sought to brighten up the mood by saying that the sector had been brought under greater market discipline as the better-performing companies continued to raise funds while those with asset quality concerns were subjected to higher borrowing costs. But that may not be enough; the regulator needs to think about proactive steps to help prevent a contagion risk.