Some stability returns

RBI report suggests banks weathering pandemic

The Reserve Bank of India (RBI) on Thursday released its Financial Stability Report (FSR), which analyses the macro-financial risks facing the Indian economy. The RBI’s opinion on financial risks, particularly to the banking sector, is important at a time in which the Indian and global economies are still suffering because of the effects of Covid-19. Some sectors were brought to a standstill and the pandemic had a very uneven effect across industries and geographies. In this context, the FSR has some relatively good headline news. In particular, the RBI’s stress tests suggest that the health of the banking sector might in fact be better than what was earlier expected, in particular in the last FSR issued in January this year. The FSR said the gross non-performing assets (GNPA) ratio of scheduled commercial banks might increase from 7.48 per cent in March 2021 to 9.8 per cent by March 2022 under regular, or baseline, macro-economic conditions. Under the severest stress scenario that the RBI tests, the GNPA ratio would go up only to 11.22 per cent. By comparison, the January 2021 FSR had argued that the GNPA ratio would increase to 13.5 per cent by September 2021 under baseline conditions.

This is thus a clear indication that the banking sector, at least, is less of a concern today — in spite of the end of the moratorium in March 2021 — than at the beginning of the year. Overall, provisioning for NPAs over 2020-21 declined by 2.2 per cent across all banks. Public sector banks remain more stressed than their private counterparts, however, with their GNPA ratio expected to be at 12.52 per cent in March 2022 against 9.54 per cent in March 2021. But, the RBI argues this is also “an improvement over earlier expectations”, and is “indicative of pandemic proofing by regulatory support”.

The FSR does highlight some of the risks to the financial sector, including those that are a product of the expansion of government market borrowing. It has pointed out that banks’ holdings of government paper are at the highest since March 2010, and that for public sector banks “held-to-maturity holdings of G-Secs have not risen commensurate to their acquisition” — meaning they are particularly exposed to yield movements. Partly this increase in holdings is accounted for by pandemic-related liquidity meeting a refusal to lend by banks. The FSR points out that for almost 800 private manufacturing companies analysed, the reinvestment of retained earnings has become the major source of funds. The banking sector’s exposure to companies shifted away from the private sector in particular, with public sector banks showing “subdued” lending to non-PSUs, while PSUs have gathered an increased share of lending from all categories of banks.

The FSR also pointed out that between September 2020 and April 2021, the asset quality of exposure to non-PSU non-financial companies showed “considerable deterioration, with migration to impaired status across all SMA (special mention account) categories”. While corporate sector lending showed the stress of the pandemic, the trend towards retail lending by banks increased: Retail credit growth stood at 11.3 per cent, year-on-year, in March 2021, as against 0.7 per cent for the wholesale sector. While extraordinary measures to shore up the banking sector have clearly demonstrated their effect, as the RBI argues, there is also no doubt that the transmission of excess liquidity to corporate lending is not happening, except perhaps for public sector companies. This may have a negative effect on the nature and timing of a post-pandemic recovery.