Although RBI’s latest Financial Stability Report says that things have stabilised, one would have to be watchful and follow developments in the next 2-3 quarters, as external economic conditions will not be too ebullient, and banks, NBFCs and cooperative banks have to pay more attention to risk to strengthen their balance sheets and make them more resilient to shocks
The Reserve Bank of India’s Financial Stability Report (FSR) is a cogent and comprehensive representation of the state of the financial sector which is brought out twice a year. It presents facts with explanations that are then iced with forecasts which point to how the regulator sees things going in the course of the year. The tone is firm without being judgemental, and it is left for the players to take necessary action to correct processes and ensure that the system is stable.
The latest FSR does indicate that the financial system has sort of stabilised, given the myriad challenges faced in the last couple of years, starting with the asset quality review (AQR) that affected public sector banks (PSBs) first, and later brought in some disruptive changes in private banks too. The good part of the story is that the NPA levels have stabilised at 9.3% (in September 2019), and, more importantly, the slippage ratio which is defined as incremental NPAs during the period under review has been stable for industry, which is a big plus. It indicates that on an incremental basis NPA accretion is moderate, and the overall NPA ratio indicates that the AQR issue is tackled almost completely. The NPA ratio has been stable for industry at 17.3%, and had risen for agriculture and services in September compared with March. The stability in the ratio for industry is indicative of the NPAs being fully recognised. In fact, the slippage ratio for industry at 3.8% is lower than that in agriculture and services.
The fact that the CRAR (capital to risk weighted assets ratio) has improved to 15.1% is reflective of a great deal of resilience built in the system, with substantial support coming from the government in the form of recapitalisation of PSBs. Only one bank had a ratio of less than 9%. Also, the provisions coverage ratio at 61.5% shows that the banking system has largely gotten out of the rather nasty phase that lasted for around three years. And most assuring, the FSR also says the network analysis shows that there was a marginal decline in the bilateral exposures between entities, which means that the interconnected risks across sectors have stabilised. Therefore, the big plus of the system in the last six months is that, notwithstanding the NBFC crisis and the Punjab & Maharashtra Co-operative Bank (PMC) controversy, the financial system is back on its feet.
RBI is, however, cautious in the future outlook, where it has projected an increase in the gross NPA ratio to 9.9% in September 2020. This does not really cause alarm, but raises the flag that the system may not yet be out of the woods. It is indicative of the fact that overall GDP growth till Q2 of FY21 may still be uneasy, and the acceleration that may have been expected next year would not be witnessed during the first half of the year. The current economic slowdown, which is flagged by RBI, is hence expected to increase the numerator and result in incremental NPAs. One must remember that even the retail segment is witnessing a slight uptick in the NPA rate, as the slowdown also affects the ability of individuals to service their debt. Also, while the SME NPAs are not going to be recorded as being impaired as of March 2020, the same would be recognised subsequently unless there is a new dispensation that defers such assets. Hence, this will be something to look out for as it can get problematic if the volume increases.
The second factor flagged is that the denominator will increase at a slower rate as credit is likely to be sluggish. This is an important and critical judgement as banks today have surplus liquidity that is not being deployed due to both lower demand and relatively some extra caution being exercised while lending. In a way, it is also reflective of the implicit view on future GDP growth that may not be significantly higher than the 5% expected in FY20, in FY21. The finance minister has subsequently assured bankers that there should be no fear in lending as it would be within the domain of banks to escalate cases to the investigative agencies in case of suspicion of wrong doing. It needs to be seen if bankers feel assured on this count.
An interesting outcome of the stable picture presented is the capital adequacy ratio of 15%. While it was necessary for banks to be well-capitalised to fund future growth, the CRAR is a delicately balanced concept. A low CRAR restricts lending, while a very high ratio means that banks are not making good use of their capital. This has happened as their balance sheets have not expanded through credit but investments in G-Secs, given the share of PCA banks—those under RBI’s prompt corrective action—in the story. The focus must be on expanding credit in a judicious manner, or else it will not be an efficient use of capital. Quite clearly, banks must use their capital in lending, or else the purpose of dis-intermediation would be dented.
The other area of concern has been the non-banking financial companies (NBFCs), and here RBI is more cautious. The fact that funding to these institutions has been a challenge from markets as well as banks is well known. The asset-liability mismatch that engendered the crisis is being addressed gradually by NBFCs, which will help in stabilising the system. However, given that this would take time to work out, one may expect the situation to linger for a couple of quarters, and it is here that RBI has waved the flag again on the possibility of their NPAs increasing.
In this context, the FSR has also analysed the real estate sector and the exposures of financial institutions.
Interestingly, it shows that PSBs have lowered their exposures to this sector, while that of private banks and housing finance companies (HFCs) have increased. But in terms of impaired assets being carried on their books of this sector, PSBs have the highest ratio of 19%! Quite clearly, the credit standards are different for various imitations when lending to the real estate sector.
Hence, on the whole, the FSR does say that things have stabilised, though one would have to be watchful and follow developments in the next 2-3 quarters, as external economic conditions will not be too ebullient and banks, NBFCs, cooperative banks have to pay more attention to risk to strengthen their balance sheets and make them more resilient to shocks. The financial system is definitely on the right path, but should tread cautiously as the economic cycle turns around.
The author is chief economist, CARE Ratings. Views are personal