Bringing Light To The Loan Moratorium ‘Black Box’

Mandate Standardised Disclosures

An easy place to start would be a standardised disclosure format. This can be mandated by the RBI as the regulator of banks or also the capital market regulator since a loan moratorium is a material event.

Both regulators, in diverse circumstances have used disclosures as a way to bring clarity to businesses. For instance, the RBI did it when it asked banks to disclose divergences in asset quality. The Securities and Exchange Board of India did it with credit rating agencies when it sought standardised disclosures on default metrices.

Either way, a standard disclosure should be prescribed for comparability.

What should it hold? There are two levels of basic information.

Mandated Disclosure 1

The first level of disclosure should simply include the percentage of customers that have applied for moratorium and the percentage of loans under moratorium. Now most private banks have already done this but some public sector banks and NBFCs have not. A break-up of moratorium assets by broad loan categories should also be mandated.

In the case of retail loans, banks can be asked to break-up the advances under moratorium into product categories. That would allow investors to judge the risk of default based on historical trends and the ability of lenders to recover dues in the case of secured loans.

Judging Risk To Asset Quality

Now lenders have said that the proportion of loans under moratorium doesn’t say anything about eventual asset quality. A number of borrowers are simply choosing to conserve liquidity.

Okay. So how do we judge what proportion of the moratorium has been taken by companies that had strong balance sheets going in to the crisis? And what part has been taken by companies which were already weak?

That brings us to the second level of disclosure.

Disclosure 2

Lenders can be asked to break-up loans under moratorium into rating categories based on internal or external ratings.

So, a lender can disclose the percentage of loans under moratorium which had an investment grade rating before the standstill was announced. Similarly, the share of moratorium loans with sub-investment grade borrowers and those that fell into different ‘special mention account’ categories before the moratorium can also be disclosed if applicable.

Investors and analysts can then judge what the eventual default risk may be for these borrower categories.

In the case of retail loans, where there is a fear that a hit to jobs and incomes could increase the risk of default, banks can be asked to disclose share of moratorium loans within different credit score categories.

For instance, if a bulk of lenders’ retail loans under moratorium fall in the ‘above prime’ category, the risk of eventual default may be perceived as lower. The reverse may be true if a bank or non-bank lender has a large share of ‘below prime’ customers that have availed of the moratorium.

Lenders Can Go Above And Beyond

While the disclosures listed above can be standardised to allow analysts and investors to compare metrics across lenders, banks and non-banks can choose to go above and beyond at their own discretion.

For instance, lenders with a large corporate book can disclose industry-wise segmentation of moratorium accounts. This would be welcome given the widely varying impact the Covid-19 crisis is having on different industries.

Lenders can also use common metrics such as interest coverage ratio and give a sense of how strong or weak borrower balance sheets were going into the Covid crisis. For instance, if a large segment of corporate borrowers under moratorium had an interest coverage ratio of less than 1, it would be fair to fear that defaults would be more likely.

In addition, they can consider disclosing share of moratorium loans in different exposure buckets. For instance, the percentage of accounts under moratorium with an exposure of, say, Rs 50 crore and above. This would help judge concentration risk within the pool of loans under standstill.

For retail lenders, disclosures such as past incidence of default in borrowers under moratorium can be disclosed. Bajaj Finance, which issued such disclosures along with its fourth quarter earnings, deserves credit. Other lenders should consider similar disclosures if they genuinely want to provide clarity to investors.

Remember, India has the largest proportion of loans under moratorium globally and any insights on the eventual outcome of this portfolio is critical to banks, investors and the economy.

A Note To The Regulator

Along with lenders, the banking regulator would also do well to disclose as much as it can to help judge the extent of systemic risk. This would be even more critical if the regulator decides to yield to requests for a one-time restructuring scheme.

A one-time restructuring, without an asset quality downgrade, atop a six-month moratorium would send the banking system into the abyss of previous years where bad loans were widely under-reported.

In that context, the upcoming Financial Stability Report, which is usually released by the RBI at the end of June, will be crucial. Disclosures on system-wide trends of moratorium accounts would be useful.

Also, the regulator typically gives ‘stress scenarios’ for the economy and projects likely levels of bad loans and bank capital requirements under those scenarios. One hopes that those stress scenarios are realistic ones and give a clear picture on what the Indian banking system must brace itself for.

Ira Dugal is Editor - Banking, Finance & Economy at BloombergQuint.