Indian banks are getting a better grip on their bad debt situation and non-banking financial companies (NBFC) are expected to regain their niche after a turbulent one year, but further reduction in bad debts and credit growth depend upon how fast the economy recovers from the slowdown, the Reserve Bank of India (RBI) said on Tuesday.
In this slowdown, banks and non-banks are shrinking their credit to the commercial sector, while uncertain times could increase the spectre of default in retail loans as well, the RBI’s Report on Trend and Progress of Banking for 2018-19 warned.
Credit to the commercial sector shrank by Rs 52,971 crore during April-September in the first half of 2019-20 from an expansion of Rs 3.66 trillion in the same period a year ago, the RBI said in its report. The risk-free retail segment doesn’t look that risk-free, either.
“While banks have oriented their lending towards the relatively stress-free retail, the slowdown in private consumption spending has imposed limits to this growth strategy even as the possibility of defaults among retail segments rises as growth slows down,” the report said.
But weakening growth impulses and subdued credit off-take, along with sporadic credit default events and incidents of frauds, are “exacerbating the reluctance to lend,” the report said, adding this “waning of confidence is weighing on overall economic activity”.
“The evolving macroeconomic scenario, and particularly, the ongoing loss of pace in domestic economic activity, present daunting challenges as widespread risk aversion has turned credit demand anaemic even as corporations deleverage their own stressed balance sheets,” the report said, adding this was taking hold at a time when recent improvements in asset quality and the profitability of the banking sector are at a nascent stage and the capital adequacy ratios of public-sector banks (PSBs) were being shored up through recapitalisation by the government. In this environment, even after having an effective bankruptcy code, the “overhang of NPAs remains,” and “further improvements in the banking sector hinge around a reversal in macroeconomic conditions”.
The banking system’s gross NPA (non-performing asset) ratio declined, after seven years, from 11.2 per cent in March last year to 9.1 per cent in March this year, and the sector became profitable in the first half of 2018-19 owing to lower provisioning.
Recapitalisation in this period also helped them shore up their capital adequacy ratios.
Recovery improved in the year due to the Insolvency and Bankruptcy Code (IBC). But recovery rates by other resolution mechanisms declined in 2018-19, especially through the mechanism of the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act.
The RBI welcomed the decision of merging public-sector banks, stating that the exercise would likely “transform the face of the banking sector.”
“With the emergence of stronger, well-capitalised banks aided by cutting-edge technology and state-of-the-art payment systems, Indian banks have the potential to become global banking leaders,” the RBI said.
While the government and the RBI have played an active role in the revival of both banks and non-banks, “the need of the hour is to continue the policy co-ordination with a view to developing a vibrant and secure banking system and a competitive and resilient NBFC sector”.
However, the recapitalisation of public-sector banks remains an unfinished agenda. Banks need capital not only to meet the regulatory minimum but to guard against balance sheet stress, as well as to improve their valuation methodologies, credit monitoring, and risk management strategies to build resilience.
While private banks had taken over the space vacated by the risk-averse public sector banks, “fault lines are becoming evident” in the corporate governance of the private banking industry. This is happening at a time when public-sector banks’ balance sheets have not yet regained their strength.
Bank lending to NBFCs remained strong because of policy initiatives, but banks must focus on risk pricing to avoid building up excessive risk.
The balance sheet size of the NBFC sector was roughly 18.6 per cent of that of the banks. Therefore, faced with stress after the IL&FS crisis, the RBI and the government took measures to allay investor apprehension and aid NBFCs to perform better.
“Going forward, the Reserve Bank will continue to maintain constant vigil over NBFCs and take necessary steps to ensure overall financial stability,” the report said.
Urban cooperative banks continue to suffer from a low capital base, weak corporate governance, inability to prevent frauds, a slower adoption of new technology, and inadequate system of checks and balances. They need to break out of these drags, the RBI said, keeping in mind the recent scam at Punjab and Maharashtra Co-operative Bank (PMC).