The Reserve Bank of India Headquarters in New Delhi (Photographer: Kuni Takahashi/Bloomberg)

Bad Loans May Rise To More Than 10% By March 2018, RBI Warns

India’s gross bad-loan ratio may rise to more than 10 percent by March 2018, the Reserve Bank of India said on Friday.

In the financial stability report released by the banking regulator, the RBI noted that the gross non-performing assets (NPA) ratio of the banking sector has already risen to 9.6 percent as on March 2017, from 9.2 percent as on 30 September.

Net NPA ratio of the banking system rose marginally to 5.5 percent at the end of the last financial year, as compared with 5.4 percent in the July-September quarter.

Public sector banks continued to be the underperforming segment among scheduled commercial banks, as their gross NPA ratio showed a consistent rise since March 2013. NPAs in public sector bank loans to industries worsened to 22.3 percent as on March 31, 2017, from nearly 20 percent in September last year

Stressed Assets Ratio Improved

Stressed assets ratio in banks, however, showed some decline, coming down to 12 percent in March 2017, as compared with 12.3 percent in September 2016. The decline was owing to a reduction in the level of restructured advances on bank books, the regulator said.

However, stressed advances in the industries segment continued to worsen, rising to 23 percent of total advances in March, as compared with 22.3 percent in the same month last year. The ratio worsened primarily due to segments such as cement, vehicles, mining and quarrying and basic metals, RBI said.

Bad Loans May Rise To More Than 10% By March 2018, RBI Warns

RBI Stress Test

The central bank’s stress test revealed that under severe macro stress conditions six banks may end up with capital adequacy ratios below 9 percent by March 2018. Under such severe stress scenario, the system level capital adequacy ratios may decline to 11.2 percent by March 2018 from 13.3 percent in March 2017.

The regulator also noted that banks face a severe credit concentration risk. Stress tests on banks’ credit concentration risks on their stressed advances portfolio showed that 12 banks may fail to maintain 9 percent capital adequacy ratio in the extreme scenario of the top three individual borrowers failing to repay.

Big Borrowers Adding To Stress

Large borrowers accounted for 56 percent of gross advances and 86.5 percent of gross NPAs of scheduled commercial banks, whereas, top 100 large exposures accounted for 15.2 percent of gross advances. A large borrower is defined as a borrower with aggregate borrowing worth Rs 5 crore and above.

The category 2 of special mention accounts (SMA-2), as percentage of gross advances, also declined across bank-groups. Moreover, the share of large borrowers in scheduled commercial banks’ total loans as well as GNPAs showed a reduction between September 2016 and March 2017.

While the level of GNPAs of large borrowers increased between September 2016 and March 2017, their restructured standard advances declined during the same period resulting in reduction of total stressed advances by 1.8 percent.
RBI Financial Stability Report, 2017

In its assessment of borrowers, the regulator noted that while the performance of some of the non-government non-financial companies improved at the end of the last financial year, the quantum of weak companies increased. The share of these ‘weak’ companies in total debt of the sample increased to 30.2 percent during the second half of 2016-17 from 28.7 percent during the second half of 2015-16. However, the debt-to-equity ratio of these ‘weak’ companies declined to 1 from 1.8 during the same period.

A risk profile of select industries, at the end of March 2017, showed that the telecommunications industry had the largest debt with negative profitability, the RBI said. The industry also had relatively high leverage. The power, construction and iron and steel industries suffered from relatively high leverage and high interest burden, it added.

In a direction to banks on April 18, the regulator had warned about the telecom sector and had said that banks must closely monitor the exposure there.

Bad Loans May Rise To More Than 10% By March 2018, RBI Warns

Banks Losing Share In Credit

Banks’ share in the flow of credit, which was around 50 percent in 2015-16 declined sharply to 38 percent in 2016-17. However, the aggregate flow of resources to the commercial sector was not affected owing to a sharp increase in private placements of debt by non-financial entities and net issuance of commercial papers (CPs); the aggregate share of these two in total credit flow to the commercial sector increased to 24.3 percent in 2016- 17. Moreover, there was increasing intermediation of credit by mutual funds.

Bad Loans May Rise To More Than 10% By March 2018, RBI Warns

Macroeconomic Assessment

In his foreword to the financial stability report, RBI Deputy Governor NS Vishwanathan noted that while the macroeconomic outlook remained positive, weak investment demand was a significant challenge.

Retrenchment of credit by public sector banks has been partly offset by non-banking financial companies (NBFCs), mutual funds and the capital market but they cannot fully substitute for banks in a bank-based financial system like ours, the central banker noted.

“Hence, steps to restore health of banks assume urgency,” Vishwanathan said.

Bad Loans May Rise To More Than 10% By March 2018, RBI Warns

The regulator has initiated prompt corrective action (PCA) in banks for this purpose, while also taking proactive measures in curbing the stressed assets in banks, he added.

In his foreword, the deputy governor also pointed out that while these measures are being implemented, nothing can replace credit discipline and appreciation of the sanctity of commercial contracts in order to ensure a robust financial system.

Thus additional focus has to be on strengthening the internal governance framework of financial entities and observance of market discipline. This will have a salubrious impact on financial intermediation whereby assumption and sharing of risks is based on risk capacity and not on herd instinct or accounting and regulatory dispensations.  
NS Vishwanathan, Deputy Governor, Reserve Bank of India

Regulatory Outlook

The central bank expects banks to face some stress on their books owing to the move to Indian Accounting Standards (IndAS) by April 2018. In a speech last week, Deputy Governor SS Mundra had pointed out that international experience showed a 30 percent higher provisioning owing to the move to higher accounting standards.

This addition in provisioning was primarily because banks will be considering expected losses on loans, rather than reported losses on their books before provisioning.

In its assessment, the RBI said that considering the threats emanating from cyber crime, with the recent global ransomware attacks, it had joined efforts with other regulators to create an interdisciplinary standing committee on cyber security.