Defusing stress

RBI report underlines that the bad loan problem will get worse before it gets better. In long run, bank governance will be key

The latest edition of the Financial Stability Report released by the RBI makes for grim reading. It has warned about the worsening asset quality of Indian banks, both public and private, besides further pressure on profitability. The FSR says that gross bad loans rose to 10.2 per cent in the quarter to September from 9.6 per cent six months ago and that the banking stability indicator shows that risks remain at an elevated level weighed down by further asset quality deterioration. And going by the stress tests conducted by the banking regulator, gross NPAs may rise to 10.8 per cent by the end of March 2018 and to 11.1 per cent by September 2018, if economic conditions do not improve.

Given the state of the economy, it is hardly surprising to see the worsening of the gross NPA ratio of large borrowers —from 14.6 per cent to 15.5 per cent in the period between March to September this year and the high credit concentration risk arising from exposure or lending to a select band of borrowers in the case of nine banks. Just as it was the last time well over a decade ago, when the government had to step in and support several state-owned banks in the wake of a prolonged slowdown, this time too, the lenders controlled by the government dominate the list of those weighed down by bad loans. But this time what’s more worrying is the secular trend — with private banks too being singed in this slowdown, given their growing share of the business pie over the last decade and the huge divergences in reporting of their bad loans after RBI asset quality reviews compared to their PSU peers. “The overall risks to the system arising from asset quality concerns continue to persist”, the report says, while indicating that six banks could see their Capital Adequacy Ratios fall below the mandated level of 9 per cent by September 2018. That, and the downside risks of corporate deleveraging and muted loan growth and the fact that banks have to transit to new accounting standards next year, have prompted the government and the RBI to announce a recapitalisation plan aggregating Rs 2.11 lakh crore over two years. But the recap plan should be just the first building block.

Far more critical to promoting a sound and professional banking sector is governance — which should be ensured by both the government and the RBI this time around to prevent or limit further drawdown of public funds in future. With signs of some of the resolution plans under the Insolvency and Bankruptcy Code set to come to fruition next year, a global recovery underway and with the rebuilding of supply chains post-demonetisation and GST, fortifying bank balance-sheets should help when the economy gathers steam after a few more quarters. Equally, with growing financialisation, as reflected in the Assets under Management or AUM of the Indian mutual fund industry of Rs 22.73 lakh crore at end November this year, the risk migration from banks to mutual funds is something financial regulators need to keep a watchful eye on.