Budgetary provisions necessary to tackle ballooning bad loans

It’s a testy beginning for the Indian banking sector. That bad loans are set to rise is a well-travelled fact, but the RBI now believes that its own assessment may not reflect the underlying gravity of the situation. This is concerning. In its latest Financial Stability Report, the central bank estimated that gross NPA ratio may touch 16.2% by September 2021, up from 9.7% in September 2020.

But in view of the regulatory forbearances like the moratorium, the standstill on asset classification and restructuring, the reported bad loan data isn’t conclusive and hence the RBI duly warned that its stress tests may not capture the ground reality and the projections were susceptible to change in a non-linear fashion.
Rising bad loans leave two troubling consequences.

One, banks’ profitability continues to suffer and two, it forces the government to infuse capital in state-run banks even if the nation’s finances are choked. That’s something the government wanted to do away with. So it pursued the massive bank clean-up exercise, infusing Rs 3.56 lakh crore between FY16 and FY20, so that banks can stand on their own.

Subsequently, it merged several PSBs in 2019, hoping that the combined balance sheet strength will allow them to raise capital from the market and lessen government burden. Going by this spirit, it made no allocation in the previous Budget, but Covid-19 forced the finance ministry to approve Rs 20,000 crore capital infusion last September. This is sufficient for FY21, but what about next fiscal?      

The good news is, as part of Covid-19 relief measures, the RBI allowed banks to provide for stressed assets from operating profits in a staggered manner stretching over the next couple of years. But should bad loans surge more than anticipated, PSBs cannot absorb credit losses and their low valuations make it difficult to tap capital markets. This was evident from the recent attempts, which saw rather limited investor interest. It means the government must continue supporting PSBs next fiscal as well and make allocations in the upcoming Budget.