Loan moratorium over, what's next for banks?

India's banking sector may start to see a substantial rise in bad loans as the loan moratorium period has ended, despite the Reserve Bank of India (RBI) allowing a one-time loan restructuring for borrowers under stress due to the COVID-19 pandemic, said banking analysts.

The impact will be visible in the second and third quarters of this fiscal year, they added.

The RBI's six-month moratorium on all term loans got over on August 31.

The central bank has permitted a one-time loan restructuring for all Covid-linked loans. By doing so, the regulator allowed banks to relax terms of a loan that can be done either by extending the payment period, cutting the rate of interest or by offering a payment holiday.

However, the recast offer has come with riders. Banks need to set aside corresponding provisions for all loans that are recast. An RBI-appointed panel is working out the modalities of the moratorium scheme.

Pain inevitable, not sure how big: Analysts

Most analysts believe that the impact of the Covid-19 pandemic will reflect in banks' books sooner than later, but there is no certainty on the depth of the problem.

Siddharth Purohit, analyst at SMC Global Securities, said the rise in bad loans will likely reflect only in the second quarter. “The real impact will be visible in Q3 and Q4. Much will depend on how many loans will be eligible for restructuring facility. It is very difficult to quantify the ultimate impact,” he said.

A loan is tagged as non-performing asset (NPA), if it hasn't been repaid for a period of 90 days.

According to Purohit, credit cost will go up for banks. Also, the impact on mid-size corporates will be huge and result in more trouble in FY22. “Somewhere down the line, the impact for mid-corporates will be huge. Typically, these companies manage their cash flows for two quarters even if there is an impact, but not beyond that,” he said.

According to Jaikishan Parmar, analyst at Angel Broking, the restructuring scheme will help banks to an extent. “Restructuring is a well thought out exercise. The timebound manner in which this is being done makes the scheme unlike the past recast exercises where the facility has been misused,” Parmar said.

However, even with the recast, the jolt on banking sector will be substantial, Parmar said. “We have to see how much stress is coming. At this stage, no one knows the exact impact. A 30-40 per cent increase in gross NPAs even with restructuring is likely,” Parmar said.

"The gross NPAs, which are worth Rs 8-9 lakh crore at this stage, could increase to about Rs 11-12 lakh crore in the next one year,” Parmar said.

Banks have made substantial provisions in the last two quarters to cover the likely impact of the Covid-19 pandemic on their portfolio.

A similar view was shared by Sanjay Agarwal, senior director, CARE ratings. “There will be some pain. But there is unlikely to be a spike. One can’t qualify how big will be the pain,” Agarwal said.

RBI warnings

In multiple reports, the RBI had warned the banking sector about a substantial pick up in bad loans. In the last Financial Stability Report, the RBI said the gross NPAs of the banking sector could rise to 14.7 per cent by March, 2021, in the worst case scenario.

Later, in its 2019-20 annual report, the central bank said regulatory dispensations that the pandemic has necessitated in terms of the moratorium on loan installments, deferment of interest payments, and restructuring may have implications for the financial health of banks, unless they are closely monitored and judiciously used.

“Although gross and net NPA ratios had come down in March 2020 along with receding slippage ratios, the economic fallout of the pandemic is likely to test this resilience, especially since the regulatory accommodations announced in the wake of the outbreak have masked the consequent build-up of stress,” said the RBI in its report.

Beginning March, the RBI had announced several measures to help the coronavirus-hit economy, including a six-month moratorium on loans and a one-time loan restructuring of loans impacted by the COVID-19 pandemic.

These measures have averted a big spike in NPAs for now.

The RBI, citing the macro stress tests reported in the July 2020 Financial Stability Report, said the NPAs may surge 1.5 times above their March 2020 levels under the baseline scenario and by 1.7 times in a very severely stressed scenario. The system level CRAR can drop to 13.3 per cent in March 2021 from its March 2020 level under the baseline scenario and to 11.8 per cent under the very severe stress scenario.

How bad will be the NPA problem?

For bank, it's difficult to gauge the impact. They can’t predict how many of these borrowers have opted for this scheme under genuine stress and how many have opted to simply defer EMIs.

According to rating agency CRISIL, 75 per cent of companies availing of moratorium are sub-investment grade.

CRISIL analysed over 2,300 non-banking financial companies (from its rated portfolio) that availed of the moratorium to tide over the Covid-19 pandemic-induced cash-flow challenges, after categorising them by rating, sector and size. It revealed divergent trends.

“Three out of four entities that availed of moratorium are rated in the sub-investment grade. Most of them were grappling with a slowing economy before the pandemic began. The severely curtailed business activity that followed in the first quarter of this fiscal had cramped cash flows, so the moratorium came as a big relief,” the agency said.