Ballooning non-performing assets (NPAs) have stalked the banking sector for much of the past decade. However, thanks to a slew of initiatives by the Reserve Bank of India (RBI) and the government, net NPAs fell to nearly a third of their FY18 peak of 6% in Q2FY22. And as gross and net non-performing assets moved south, and the provision coverage ratio (PCR) and capital buffers improved, banks’ profitability indicators got back to their pre-pandemic levels. But now, lenders could witness a higher level of NPAs as a chain effect of various sectors affected by the Russia-Ukraine crisis, according to analysts. India Ratings and Research (Ind-Ra) projects that the debt at risk (with net leverage exceeding 5x) would exceed by ₹1.2 lakh crore against what was anticipated prior to the war.

“While NPAs have come off their FY18 peak consistently, they still remain far away their all-time lows, indicating recovery is mid-way and a slowing economy could still pose a risk,” says Garima Kapoor, economist, Elara Capital.

There will be a two-pronged impact of the war on the Indian industry, adds Krishnan Sitaraman, senior director and deputy chief ratings officer, CRISIL Ratings. “One, the resultant spike in commodity prices, if not passed on, can increase input costs and squeeze the margins of downstream sectors. Two, trade and banking sanctions can cull India’s export-import activity in the affected region till workarounds are found.”

“Russia ($10 billion) and Ukraine ($2.5 billion) are not significant trade partners for India. However, the impact of the war is most likely to be felt through global supply chains, especially in sectors where Russia is a key exporter and India a net importer (fertilisers and edible oils),” says Kapoor of Elara Capital. The war has also affected domestic inflation in the form of steep rise in prices of fuel and edible oil over the last couple of months, eventually leading to a policy rate hike in last month. To counter the effect, Indian Oil Corporation (IOC), in mid-March, bought 3 million barrels of Urals for May delivery at a discount of $20-25 a barrel to dated Brent. Other companies are also expected to follow suit.

Deferred recognition of Covid-19 driven loans, one of the main reasons for the decline in reported NPAs and higher profits for banks, will bring more NPAs into the reckoning, especially with the regulatory forbearance on restructured standard advances (RSAs) coming to an end on March 31, 2022 (The RBI had allowed banks to give a two-year moratorium in repayments under the restructuring scheme). “There is a possibility of RSAs relapsing into NPAs due to different waves of Covid-19 affecting the industry from time to time, as the facility can be availed only once,” says Ramnath Pradeep, former chairman and MD, Corporation Bank.

“We remain watchful of the stress emanating from RSAs of banks, which we estimate to be 3% of their advances,” says Anil Gupta, vice president & co-group head, financial sector ratings, ICRA.

Frauds Far From Over

Besides, the string of corporate frauds on banks seems endless. The ₹22,842-crore ABG Shipyard bank loan fraud, billed as the biggest among its ilk and affecting 28 banks, including State Bank of India, is only the tip of the iceberg. Other skeletons are tumbling out of the closet slowly, highlighting the bigger malaise within, which is set to weaken the banking system further. Most of these loans have been provided for fully by banks.

It all started with Kingfisher Airlines and Nirav Modi (involving around ₹10,000 crore each in fraudulent activities). But the loan fraud that shook the financial system as a whole was that of the IL&FS Group. The NBFC, with at least 24 direct subsidiaries, 135 indirect subsidiaries, six joint ventures, and four associated companies, had a debt of around ₹91,000 crore. The other intriguing case was that of Yes Bank, where the erstwhile promoters were accused of favouring some industrial groups by loan disbursements in quid pro quo deals.

The ₹3,250-crore Videocon loan scam, the ₹8,100-crore Sterling Biotech default by Sandesaras, the ₹7,000-crore Winsome diamonds loan default and the siphoning off of over ₹1,000-crore funds of Bhushan Power & Steel Ltd (BPSL) are some of the other examples.

According to the RBI, the total credit of the Indian banking system was at ₹120 lakh crore as on May 6, 2022.

Banks are the first line of defence for timely detection of a loan turning into an NPA or diversion of funds. When funds are diverted, the first signs can be traced by the bank when a cheque is issued or payment is made to an unconnected person. Bank policies detail out the process to be followed while arriving at a credit decision. Similarly, there are clear instructions issued by the central bank on ‘wilful defaulters’. After the identified defaulter has responded to the 15-day notice, the bank committee has to pass a reasoned order identifying the root cause of the default/fraud, after giving an opportunity of personal hearing to him/her.

“However, some banks’ committees/ authorities are not passing such a reasoned order. There are cases of faulty decisions purely on the part of the bank but the entire blame is attributed to the borrower due to the definition provided in the RBI guidelines to declare somebody a wilful defaulter. There is a need to revisit those guidelines,” says Pradeep. “Only industrialists/ entrepreneurs are blamed every time there is a default, and that too when a big one comes to light. Senior officers and auditors entrusted with the responsibility of overseeing systems and processes that try to ensure tracking of major loans likely to go bad in the first place, are not being asked for an explanation.

“There is a need to carry out a forensic audit every year of the bank and borrower company immediately after finalisation of the audited balance sheet of banks and borrowers. This would give both an opportunity to take timely and corrective action,” he adds.

The borrower is charged with cheating and criminal conspiracy, under various sections of the Prevention of Corruption Act, 1988.

“The same way, central/ statutory and concurrent auditors, who have audited and certified a bank’s accounts and balance sheet as well as borrower companies’ accounts every quarter (for listed ones), are not being questioned about the deviations and diversions of funds by borrowers. Merely blaming the borrower for every fault is not correct,” says Pradeep.

The Changing Scenario

But that is not how the banking scenario seemed in February. In a report released just before the Russian invasion, Ind-Ra had revised the banking sector outlook upwards for FY23. “The improving health trend that began in FY20 is likely to continue into FY23. Furthermore, key financial metrics are likely to continue to show improvement in FY23, backed by strengthened balance sheets and an improving credit demand outlook with an expected commencement of the corporate capex cycle,” Karan Gupta, director, financial institutions, Ind-Ra said in the report.

Gross NPAs (GNPA) ratio (as a percentage of gross advances) and net NPAs (NNPA) ratio of scheduled commercial banks (SCBs) continued their declining streak from FY18 peak of 11.21% to 6.9% in end-September 2021 (Q2FY22) and from 6% to 2.2%, respectively.

In financial terms, outstanding bank credit has grown from ₹85.12 lakh crore in end-March 2018 to ₹107.38 lakh crore in end-March 2021. During the same period, the industry GNPA has come down from around ₹9.55 lakh crore to ₹7.89 lakh crore, while NNPAs dipped more than half from ₹5.07 lakh crore to ₹2.56 lakh crore.

Overall, the net profit of SCBs rose to ₹78,729 crore at the end of September 2021, up 32.48% year-on-year (YoY). The sector reported a return on assets (RoA) of 0.79% in September 2021 (Q2FY22), against a de-growth of (-)0.15% in March 2019. After recording negative profitability ratios from March 2016 to March 2020, the RoA of PSBs turned positive in June 2020 and has been on an upward trajectory since.

The banking sector reported 1% RoA (annualised; highest in 30-32 quarters) in Q3FY22. Private banks reported an RoA of 1.6% (annualised; highest in 24 quarters) and PSU banks 0.6% (annualised; highest in 30-32 quarters). Summarising these benchmarked figures from Q3FY22 results in its review report, Edelweiss Private Wealth Research said, “We believe the current trend will continue on account of improving business activities, and moderating credit costs.”

Meanwhile, the RSA ratio of SCBs has grown from 0.4% to 1.5% between March 2019 and September 2021, boosting the ratio of stress assets to 8.5% in September 2021, compared with 7.9% a year ago.

Various Covid-related dispensations/ moratoriums provided with respect to asset quality contributed towards increase in restructured assets, according to the Economic Survey 2021-22.

However, CRISIL said recently that its Financial Conditions Index (FCI) eased in April relative to the previous month as some of the global headwinds triggered by the Russia-Ukraine war stabilised.

Improved Recoveries

Introduction of enforced, time-bound recovery and market-linked resolution mechanism, the Insolvency and Bankruptcy Code (IBC), promulgated in 2016, spurred recoveries compared to the earlier long-drawn out mechanisms like One-time Settlement (OTS), Debt Recovery Tribunals (DRT), Corporate Debt Restructuring (CDR) and SARFAESI Act, have helped banks in addressing the bad-loan situation.

Besides, “the RBI and the government have taken several steps to identify and bring NPAs down and prospectively keep the books healthier,” says Kapoor. These include Asset Quality Review (AQR), Prompt Corrective Action (PCA), Proactive Risk Management, Scale-Based Monitoring, along with resolution-focused steps such as the introduction of the National Company Law Tribunal (NCLT) and IBC, and Emergency Credit Lines Guarantee Scheme (ECLGS) for small businesses, which have helped spruce up the books of banks and NBFCs.

To further accelerate the NPA resolution process, the National Asset Reconstruction Company Ltd (NARCL) is being mooted, for debt aggregation and efficient resolution of large NPA accounts of above ₹500 crore in value, with an aggregated loan pool of ₹2 lakh crore.

Looking Ahead

Improving asset quality, profitability and capitalisation of banks indicate a strong if not robust sector compared to a couple of years ago. Capital to risk-weighted Asset Ratio (CRAR) of SCBs—which indicates bank’s capital strength and ability to take more risk-weighted loan exposures — stood at a comfortable 16.54% at the end of September 2021, with at least 2.5% more buffer than regulatory prescription.

But the bulwark of the sector is the high PCR — the level of risk coverage of banks’ risk-weighted loan exposures — at 70%, which is expected to continue, according to analysts. This could insulate the Indian banking sector from major shocks. However, there are a lot of events that could influence their future course, including the ongoing Russia-Ukraine war.

Sitaraman of CRISIL has identified factors such as trends in macro-economic environment; impact of subsequent waves of Covid-19, if any; and performance of the restructured portfolio, besides the Russia-Ukraine conflict, that could influence bank NPAs in the near- to medium- term.

Kapoor of Elara Capital, meanwhile, warns of a possible stagflationary condition (slow economic growth and relatively high unemployment accompanied by rising prices) in the economy affecting bank NPAs, over the next 6-9 months.

Gupta of Ind-Ra expects the capex cycle to gain momentum in FY23, boosting credit growth, on the back of investments under the government’s Performance-linked Incentive (PLI) scheme. The asset quality metrics will further improve going ahead, with NPA ratio for banks likely to decline to 6.3% and 6.1% in FY22 and FY23, respectively, (PSB — FY22: 8.3%, FY23: 8.1%; non-PSU — FY22: 3.2%, FY23: 3.2%), according to Ind-Ra. “Stressed assets pool, however, would still be relatively elevated at 8.7% in FY22 and 7.6% in FY23,” adds Gupta.

Hike in repo rate by 40 basis points (100 basis points equals one percentage point) in May, citing deteriorating inflation outlook, is expected raise EMIs for long-term borrowers, putting further pressure on NPAs in the coming months. Many analysts expect another 75-100 basis point hike in repo rate during the current fiscal.

Getting central vigilance agencies to investigate the commercial decisions of bank officials is increasing the ‘fear factor’, further distancing them from responsible assignments, say analysts. Only junior officers attending loan consortium meetings is, perhaps, a primary reason for many major loan defaults not coming to light till the last minute. If the RBI and banks develop remedies for loopholes identified by these agencies in each case to ensure that the same kind of frauds do not recur, the NPA situation could improve.

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