Banks’ balance sheets closer to truth as SC lifts stay on bad loans
Since lenders couldn’t label defaulters, they couldn’t chase defaulters for repayments effectively but now that is possible which is likely to show up in improved recovery
The shares of Indian banks received a booster shot after the Supreme Court lifted its stay on recognition and classification of bad loans. Since the six-month moratorium ended in August, banks could not declare defaulters following the interim stay order by the apex court.
The Nifty Bank index gained a massive 98% since the case on compound interest was filed before the Supreme Court on 27 March 2020. The rise gathered pace October onwards and has outpaced that of broader indices since then. The question is whether banks’ balance sheets are priced to truth now. Analysts said valuations have priced in the true asset quality since most lenders have disclosed their proforma bad loan ratios. Proforma ratios included the slippages otherwise not reported due to the standstill.
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While the Nifty Bank index gained marginally on Tuesday, it slipped over 2% on Wednesday.
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Whether through proforma or actual, the fact remains that banks saw stressed loans rise in Q3FY21 compared to the previous quarters. Even though the extent of rise has been lower than feared, the probability of continued stress remains. With the lifting of the stay on bad loan recognition, lenders can now begin the resolution process. Since lenders could not label defaulters, they could not chase them for repayments either.
“Withdrawal of the stay on NPA recognition will allow lenders to recognize actual NPAs and actively pursue recovery efforts," said analysts at Motilal Oswal Financial Services Ltd. Note that fresh admissions under the Insolvency and Bankruptcy Code (IBC) will begin as the suspension of the code was lifted on 25 March 2020. Bankers expect a slew of applications before the courts. But the success of banks’ recovery efforts in the case of corporate loans is sketchy at best, despite IBC. Barring select large recoveries, lenders have struggled to get their monies back and have been at the receiving end of deep haircuts.
Analysts at Edelweiss Securities Ltd said judicial intervention is a key risk for investors. “Absence of earnings materiality does not render this ruling insignificant. Judicial intervention into an essentially private commercial relationship between a bank and its customer, and that the recommendations of the court constitute a strain on shareholders, however small, would be noted," said a note from the brokerage.
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Granted, the court’s verdict on Tuesday removed the uncertainties over compound interests. Investors now know that banks need not cough up more than ₹7,500-8,000 crore towards interest waiver as it is extended to all loans. This will result in only a temporary dip in interest income. Even so, the impact on profitability hinges on how effective banks are in recovering their money and how fast or slow slippages show up. The real test begins now when lenders chase growth alongside a two-faced recovery in the economy. Valuations are yet to price in future risks completely.
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