Loan moratorium case: Adverse SC verdict could heavily affect banks in Q2

Financials of banks may take Rs 10,000 - Rs 20,000 crore of hit if interest on interest is waived

The highly anticipated Supreme Court (SC) hearing on ‘interest on interest’ for loans under moratorium is scheduled for next Monday. A back-of-the-envelope calculation indicates that banks are staring at a Rs 10,000-20,000 crore hit on their profit and loss statement if the verdict is unfavourable.
 
While this is about two per cent of total banking sector loans, analysts at Motilal Oswal Securities (MOSL) estimate that banks’ operating profits could take a 24-111 per cent hit in financial year 2020-21 (FY21). If a final verdict is delivered on Monday and is unfavourable for banks, their September quarter results may be strained.
 
News reports suggest that the Mehrishi Committee has recommended that the government bear the brunt of this liability and relief be provided to the most affected segment of borrowers.
 
While this bodes well for banks, going by precedents, analysts say they would be surprised if the government offers any support. “As per our observation, unless it is a government announced scheme like a farm waiver, it is unlikely that such costs are borne by the government,” says an analyst with a foreign brokerage.
 
Some analysts say that if the government extends any relief it may be counterproductive. “There may be an uproar that this money could have been used for recapitalising government-owned banks or serving the public directly; why help the banks instead,” the head of research at a domestic brokerage said.

 Analysts at MOSL make an interesting observation. Given how SC’s verdicts have had severe implications on the business outlook of sectors such as telecom and coal mining in the past, they say an adverse verdict could have huge ramifications on the banking sector, too. Yet, they are hopeful that considering banks’ fiduciary responsibilities to their deposit holders, the probability of an adverse verdict is minuscule.
 
Apart from the financial disruption, Suresh Ganapathy of Macquarie Capital raises concerns on the credit discipline of borrowers getting compromised. Non-performing assets of retail loans have been contained at two per cent for years, with a greater role played by credit bureau scores. Banks have improved their retail underwriting practices and are now adopting a disciplined lending approach.
 
“We are worried that waivers will set a bad moral precedence and could vitiate the credit culture among retail borrowers,” Ganapathy said. Retail was the fastest-growing segment for banks till Febr-uary. A negative verdict may deter banks from taking much exposure to the segment.
 
In other words, with a 35-per cent year-to-date correction in the Nifty Bank index, an unfavourable verdict can further aggravate the pressure on banking stocks.