India’s NPA cycle appears relentless. In 2014, bad loans were confined to the nonfinancial corporate sector. But now, the NPA fire seems spreading to micro, small and medium businesses (MSMEs), even drawing some retail loans into its fold. On the lenders side, if it were mostly banks that were overwhelmed with bad loans some years ago, it is the nonbank segment that is dragged in now. A fresh cycle of toxic assets could further pressure the financial system, which is already under tremendous strain.
Observed patterns in the March quarter results (Q4FY19) of banks indicate fresh slippages in new segments, while a few large borrowers added to the existing corpus. According to FE’s report (“NPA crisis: Why loans to MSME, real state, farmers may go bad” FE, May 27, 2019), 22 of 33 banks declaring results show a sequential increase in NPAs, with a 58% increase in overall provisioning in one quarter! Although this reflects full provisioning for some large legacy bad assets, it also includes contingency provisions for potential slippages from the stressed nonbank segment (NBFCs) that are apprehended. At end-September 2018, 52% of NBFCs’ total (non-food) advances were to industry, of which 8% went to MSMEs; 22% of this went to retail loans.
What were MSME and retail asset qualities like in 2018? RBI’s Financial Stability Report (FSR, December 2018) and Report on Trends and Progress in Banking in India (RTPBI, 2018) shed light on this for FY18 and H1:FY19, i.e. up to September 2018. RTPBI (para IV.46, Chart IV.18b) reports deterioration in MSME asset quality across banks and NBFCs in H1:FY19 as gross NPAs (GNPA) increased; the increase was smaller for micro and small industries. GNPA ratio deteriorated to 6.1% for NBFCs in quarter-ended September 2018 (March – 5.8%); the proportion of sub-standard assets rose sharply to 4.8% in six months (March 2018-3.3%) with downgrading of some standard assets (para VI.26, Chart V1.12).
A better picture of MSME credit quality across financial intermediaries is provided by RBI’s FSR, December 2018. Observed from TransUnion CIBIL database, this is more granular than supervisory returns because it “…considers an entity’s total credit exposure and classifies impaired status based on performance of related accounts…following the 90 days past due norms for impairment across institutions” (Section IV, para 2.5, FSR).
MSME credits, with much larger default transition probability, already embedded a significant default risk in the outstanding portfolio across financial intermediaries, as per March 2018 ratings—public sector banks trailed the rest in both “inherent and realised credit risk”. One-fifth of MSME exposure of NBFCs and public sector banks was in the riskiest ratings segment (CMR 7-10). NPAs as percent of relative exposure (loan size Rs 10-50 million) increased to 8.7% in H1: FY19 (8.4% in March) for micros; for SMEs, the increase was larger (11.5% from 11.1%). When compared to March 2016—corresponding numbers then were 7.9% and 9.8% respectively for micro and SMEs—the rise is sharper (Para 2.52, FSR). For banks, the NPA rate jumped to 15.2% within a quarter to June 2018 (14.4% in March), remaining static for NBFCs. About 62% and 60% of public and old, private banks’ respective exposure to the high-risk, MSME segment is plain working capital and term loan structures; the RBI notes it has previously underlined working capital frauds in public sector banks in general. Against this, 80% of NBFCs exposures (14% acquisition in this segment) are mostly asset-backed loans (e.g. commercial vehicles/equipment and/or auto, gold and mortgage loans).
The distinction between PCA and non-PCA public sector banks on MSME exposure quality (below Rs 50 million) is interesting: incremental exposure of PCA-PSBs rose 166% in one year to FY18 (FY17 – Rs 226.8 billion); the RBI warns this “…sharp increase may require examination of possible dilution of credit standards further and additions to supervisory strategy for PCA banks” (FSR, para 2.57). Finally, it is slippages of fresh acquisitions within one financial year that is concerning: for PCA-PSBs, such slippages increased to 4.7% by March 2017 from 2.6% in March 2016; corresponding increase for non-PCA PSBs was as sharp to 1.2% from 0.7%. In March 2018, fresh MSME loans and renewals by PCA-PSBs increased to 2% from 1.4% in March 2017, while similar increase was 2.2 times to 1.25% for other PSBs.
A 2% impairment rate for freshly sanctioned portfolio points to an aggravating situation in MSME loans. Since then, the eruption of the NBFC crisis pushed up funding costs while demand slowed in H2:FY19. That points to increased likelihood of further deterioration in MSME asset quality. For example, MUDRA loans extended under PMMY by banks, NBFCs, MLIs, etc. and grew very rapidly, are reported as a big source—bad loans under MUDRA were reported risen 92% in one year to FY18, followed by 53% surge in the first three quarters of FY19. The RBI was also reported to have expressed its concern to the ministry of finance in this regard in January 2019. Recent reports of a universal debt relief scheme planned for small borrowers (micro enterprises, small farmers, other individuals) may also point to aggravating NPA stress.
How about retail loans? These have been driven mostly by housing and auto loans, and credit card receivables, grown very fast and supported by government incentives, e.g. Pradhan Mantri Awas Yojana (PMAY), Real Estate (Regulation and Development) Act (RERA), and rationalisation of risk weights and provisioning on standard assets in housing loans of specific individual categories in June 2017. Has the debt stress spread towards the household sector?
The RTPBI reports retail loan defaults at banks remained at a low level; that in agriculture loans worsened as on September 2018. However, RBI’s FSR (para 2.12) shows some deterioration in retail asset quality (and agriculture) between September and March 2018 with annualised slippage ratio higher at 2.3% from 2.2% (Chart 2.3a, FSR, December 2018).
What about the quality of NBFCs’ retail loan portfolio? 65% of their retail loans are distributed across vehicles (44%) and other loans (21%). A disaggregate profile of retail portfolio of NBFCs is unavailable. But the aggregate asset quality deterioration and downgraded assets of NBFCs in September 2018 (above) may be an indicator, as might be worsened asset quality of loan companies (these mainly extend loan finance) in H1:FY19. The increase in gross and net NPAs at NBFCs is 2.2 and 2.7 times compared to four years ago (March 2014, FSR, para VI.26, Chart V1.11). The rapid loan growth at NBFCs is well known. Gross and net NPA ratios of housing finance companies (HFCs), which too grew loan books extraordinarily fast, are rising from FY18 up to by September 2018.
Overall, there are signs the NPA fire may be spreading. Incomes have decelerated since last year; debt-servicing has become costlier. That impacts both MSMEs and individual borrowers, loans to which grew remarkably fast these last few years. Policymakers need to be particularly watchful about this spread as it also shows that indebtedness in the economy is extending beyond large businesses.