The Nifty Bank index tanked 6.7 per cent on Monday. The reason, experts say, is that not only have the announcements of stimulus package by the finance minister failed to address economic growth concerns, but now, there are fears that the bad loan pressure may rise for the banking sector.

Concerns over recovery of collateral-free loans to MSMEs (micro, medium and small enterprises), suspension of Indian Bankruptcy Code (IBC) proceedings and few steps to boost credit off-take, among others, are key reasons why banking stocks saw heavy selling on Monday.

The last set of stimulus measures, which include providing collateral-free loans to MSMEs, were made on Sunday. Since the start of announcements on May 13, the banking index has shed 10.5 per cent; it is down over 18 per cent (versus 10 per cent fall in Nifty) in this month so far.

Draft guidelines by some financial institutions on Rs 3 trillion collateral-free funding to MSMEs reveal that instead of direct guarantee, these loans would have government guarantee through Credit Guarantee Fund Trust for Micro and Small Enterprises or CGTMSE. This has led to worries as MSMEs (38-50 per cent of banks’ loan book) are already a concern for lenders in terms of asset quality.

“No direct sovereign guarantee for MSME loans, which would be free of collateral, has raised concerns on recovery as the guarantee would come from a Trust,” says Deepak Jasani, head of retail research at HDFC Securities. In fact, this guarantee comes with caveats, and hence, has disappointed banks, especially public-sector banks, as the overall economic revival is likely to take time and this can impact loan recovery from MSMEs going ahead, Jasani adds. The market is awaiting final guidelines on this issue.

Senior executives of state-owned banks said the government's direct support is much less, but it has signalled public sector banks to be liberal with borrowers, especially MSMEs, during current adverse times. Borrowers, who have delinquent behaviour, would get benefit of doubt and the legal process is also going to get affected, they cautioned.

Also, the guarantee is only for the extra funding, while existing exposure is not part of the deal, says a banking expert. Thus, only 17 per cent of the total exposure will be protected by government guarantee.

There is also fear that action may be taken in future against officials if loans turned bad. An executive of a top bank, said, “Past experience shows the intent and context in which decision to give loan was taken is forgotten, and only the 'decision' and 'loan becoming bad' is kept in focus for vigilance and legal proceedings.” These concerns remain even as the government had amended rules much before Covid outbreak to address the 'fear' element in the mind of bankers.

The government having suspended Insolvency and Bankruptcy Code (IBC) proceeding for fresh cases for one year amid Covid-19, has also added to investor concerns as it could hurt loan recovery rate and spoil credit discipline amongst corporate borrowers. Analysts at Emkay Research, said, “We believe that this will be a setback for banks looking for resolution/liquidation under the legal umbrella, with no risk of witch-hunting later on and more so when another wave of corporate NPAs (non-performing assets) could be on way.”

Since its inception, the IBC has assisted banks to recover Rs 1.84 trillion (44 per cent of loans due) and instilled fear in the minds of belligerent corporates, according to Emkay Research. Sunil Jain, head of research at Nirmal Bang, echoes similar views. “Suspension of IBC proceeding has kept the recovery of chunky amount on hold, which would further delay asset quality cycle of banks,” he said.

A likely extension in credit demand revival, sustained asset quality worries for the retail segment given higher share of moratorium (25-70 per cent) are other concerns. With little direct funding from government, economic revival, mainly the private consumption, would take time and this in turn would delay recovery in credit demand, adds Jain.

Lack of measures to help revive worst-hit sectors like aviation, hotels, etc has raised fears to more loans turning bad.

Lastly, it also needs to be seen whether the stimulus package will help avoid down-rating of borrowers to below investment-grade.

Investors, thus, should wait till these clouds clear and stick to quality names, say experts.