India’s lenders had brought down dodgy loans to just 8.5% of their book in FY20 from an ugly 11.6% in FY18. It seems that was just a number on sand and all it took was a wave of a pandemic to wipe this minor victory off.
What’s more, the capital that public sector banks wheedled out of the government and their private counterparts boasted about is now looking very vulnerable. Banks would see 12.5% of their loans turn bad this year for sure. Their worst nightmare is this ratio climbing up to 14.7% under extreme duress from the pandemic. That is the number thrown by the Reserve Bank of India’s (RBI) stress tests. In the financial stability report, the central bank paints a gloomy picture on capital levels of the banks and reiterates how important it is to raise money.
Sure, India’s private sector lenders have already announced big fund raising plans with some having already mopped up money from the markets. The government has merged public sector banks in the hope that stronger balance sheets would support weaker ones.
But the fact remains that the outlook on asset quality and health of capital is still clouded and even the RBI is not offering any clarity on this. “Given the fact that impact of moratorium is still uncertain and evolving, the exact nature of how the same will play out on the quality of banking assets is difficult to ascertain accurately,” the RBI report said. But for what it’s worth, the stress tests do give an inkling of the trouble ahead.
As a base case, banks would see their capital adequacy ratio drop to 13.3% by March 2021 and the most pessimistic outcome would be a drop to 11.8%. Three banks would see their capital levels dip below the regulatory minimum and in the case of extreme stress the number of banks would go up to five.
Unsurprisingly, the weakest link are public sector banks. The pandemic would result in bad loan ratios surging to 15.1% and a bigger deterioration in capital ratios. To be sure, the stress tests have not taken into account mergers and recapitalisation by the government.
Even as stress tests throw out ugly numbers, the central bank’s report has said that the moratorium suppresses the real amount of stress on banks’ books and half of the banking system’s loan book was under moratorium as of April. To be sure, moratorium levels have come down since then.
The RBI has said that the country’s financial system remains sound. But Governor Shaktikanta Das has given sound advice in his foreword for the report. “We need to remain extremely watchful and focused.”
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