If the financial system isn’t fixed, it can’t support business, and there will be no growth.
Repo rate cuts have outlived their utility. At a time when there is such little lending, it doesn’t really matter whether interest rates fall 10 bps or 20 bps or even 30 bps. RBI Governor Shaktikanta Das is hoping to resolve the sluggish loan growth problem with a 3.35% reverse repo rate, in the belief that banks will no longer park their surpluses with the central bank, but be coaxed into lending. They may be, but only on the margin. A return of 3.35% may be very unattractive, but banks won’t be too worried, they will simply drop interest rates on deposits.
The way they see it, a very large chunk of businesses—especially in the MSME sector—is on the brink, and so, any fresh lines of credit could amount to throwing good money after bad. The extension of the moratorium on term loan repayments—to six months—will no doubt give many units a breather, but it is hard to tell whether they will survive if the pandemic compels us to leave large parts of the economy shut for a prolonged period.
In fact, even before the pandemic, loan growth was averaging 6.5% year-on-year. So, just as it was before Covid-19, only top-rated enterprises are likely to get loans, though now many more high-quality companies will need money.
There is no denying things have only gotten worse. The contraction in the economy will see an increasing number of businesses perishing leading to a new NPA cycle.
And, this time around, we could see NPAs going up all the way to 18-19% of advances compared with the last peak when they hit 12-13%. The last NPA cycle was the result, predominantly, of corporate loans going bad. Banks may have helped out businesses that need fresh lines of credit, but they are also scared of being punished; the government has not been able to reassure lenders they won’t be penalised for bona fide decisions. Also, as the NPAs start to pile up, the balance sheets of state-owned banks will turn weaker unless the government recapitalises them.
Which is why lenders are asking for a one-time loan restructuring or a bad bank.
Between the two, the former is a better idea since the exposure remains on the lenders’ books forcing them to pursue recoveries; once the exposure is off the books—as it would be with a bad bank—lenders lose interest in recoveries. It is a moral hazard because borrowers get used to the idea of a bail-out. Also, a bad bank needs to be capitalised immediately, and the government may not be able to summon the funds just yet.
On the other hand, while the restructuring is not a great idea—because it makes bankers less diligent—the current circumstances are unprecedented. So, perhaps RBI could permit restructurings and allow the exposure to be classified as a standard one, but by allowing banks to make only 50% of the additional provisioning required in the case of an NPA. This would save banks 50% of the extra capital they would need to set aside if the loan goes bad and, at the same time, not totally distort the true quality of the balance sheet. The government can then capitalise lenders at its own pace.
To guide investors, banks must put out the list of the assets restructured. Borrowers could be given lenient repayment terms—lower interest rates and longer repayment tenures, but a moratorium, as is typically given when a restructuring is done, should be avoided. RBI has extended the repayment holiday to six months and allowed borrowers to pay off the interest by March 31, but this should be withdrawn if there is a restructuring. For smaller exposures, of, say, less than Rs 1,000 crore, banks can choose between a one-time restructuring or writing off losses after settlements with the promoters.
There is an urgent need to strengthen banks’ balance sheets at a time when the economy is contracting and is putting the shadow banking sector in jeopardy. The troubled exposure that banks have to NBFCs is estimated to be close to Rs 4 lakh crore. Unless the economy picks up faster than anticipated, and the liquidity support measures help, many of the weaker shadow banks will become insolvent. Banks are as yet reluctant to help NBFCs who need to repay close to Rs 54,000 crore of bonds in June, according to Bloomberg data. Many may not be able to refinance these because the risk-averseness is so high; yield premiums on three-year rupee bonds of top-rated shadow banks over government debt of similar maturity were at close to at least an eight-year high last Friday, though they have dropped since then.
One doesn’t blame them because it is safer, in every sense of the word, to buy government bonds. Unless RBI steps in to support the government’s borrowings—a total of around Rs 9 lakh crore in 2020-21—banks have a good investment opportunity for their Rs 8 lakh crore surplus. The risks to the economy today stem from the unwillingness of banks to take risks; if they are to be prodded to take at least some risks, RBI and the government must do some hand-holding. Leaving it for later could put the financial system in further trouble.