Indian banks’ asset quality strong enough to handle shocks, says RBI; acknowledges omicron worries

The probability of a decline in bad loans still remains high, experts said, adding that banks will largely be able to manage the stress if a fresh COVID-19 wave hits.

The probability of a decline in bad loans still remains high, experts said, adding that banks will largely be able to manage the stress if a fresh COVID-19 wave hits. (File photo: Reuters)

Indian banks have remained resilient amid the pandemic recording an improved asset quality and a decline in ratio of non-performing assets at the end of September, the RBI said in a report, adding that the financial system will be able to mitigate future shocks. The probability of a decline in bad loans still remains high, experts said, adding that banks will largely be able to manage the stress if a fresh COVID-19 wave hits.

Resilience in banks’ balance sheets 

“Financial institutions in India have remained resilient amidst the pandemic and stability prevails in the financial markets, cushioned by policy and regulatory support,” the Reserve Bank of India said in its Financial Stability Report. “Balance sheets of banks remain strong and capital and liquidity buffers are being bolstered to mitigate future shocks, as reflected in the stress tests presented in this report.” Stress tests measure the resilience of banks against macroeconomic shocks.

Brokerage firm Kotak Securities said overall it sees a favorable outlook and it expects to see lenders shift to growth. “We remain optimistic that the probability of a decline in NPL (non performing loans) ratios still remains high led by lower slippages and faster recovery of NPLs,” it said in a research note. As of September, 2021, Gross non-performing assets (GNPA) and net NPA (NNPA) ratios declined to 6.9 per cent and 2.3 per cent respectively.

Recovery clouded by omicron variant

RBI, however, noted the looming worries from the newly emerged omicron variant that has been causing headwinds in global markets, adding that omicron could haunt domestic growth prospects in near term. 

“The global recovery is clouded by the emergence of the Omicron variant of COVID-19. Inflationary pressures persist and monetary policy paths are diverging among major economies. On the domestic front, the recovery is regaining traction after the debilitating second wave of the pandemic,” RBI said in the report. “The pace of the recovery remains uneven across sectors, inflation formation is being subjected to repetitive supply shocks and the outlook is overcast with global risks. Omicron haunts near-term prospects,” it added.

Banks have largely managed the stress on account of COVID-19, Kotak Securities noted. Brokerage firm Emkay Financial Services also echoed a similar view saying that the banks are well-placed to withstand the asset quality impact of mild or partial lockdowns. “However, a severe wave similar to the second wave could pose a meaningful risk to otherwise fragile growth and asset quality,” Emkay said in a note.

Enough capital to handle stress

According to the central bank’s report, stress tests for credit risk show that GNPA ratio of scheduled commercial banks’ (SCBs) may increase to 8.1 per cent under baseline scenario and to 9.5 per cent under a severe stress scenario by the end of September, 2022. The stress tests, however, also show that all banks would be able to comply with the minimum capital requirements even under severe stress scenarios, the report noted.

“RBI had earlier projected an 11.2% GNPA ratio by Mar’22 and thus the recent projections are relatively lower than earlier estimates,” Emkay Financial said in the note. 

“While the pandemic induced bouts of volatility, spillovers and heightened uncertainty are challenging, the Indian financial system has stood up well and remains well prepared to meet the funding requirements of the economy,”  RBI Governor Shaktikanta Das said in the foreword of the report.

Distressed MSMEs pose a risk

Along with touching upon strengths of the banking sector, RBI also highlighted the weaknesses faced by certain segments of the financial system. The central bank said Micro, small and medium enterprises (MSMEs)  and the microfinance segment are reflecting signs of stress. RBI has highlighted elevated risk in SME (small and medium enterprises) and MFI (micro finance Institutions) portfolios, mainly for private banks, analysts at Emkay Financial said. 

“SME/MFI remain the most vulnerable segments, and thus banks with relatively higher exposure to these segments (PSBs – mainly due to SME, Bandhan Bank, Ujjivan Small Finance Bank, IndusInd Bank Limited, Axis, RBL Bank, City Union Bank Ltd, DCB Bank Limited) could be at relatively higher asset quality risk,” according to the note.

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