Top banks hike provisions
Last updated: 27 Jul, 2020 | 03:59 pm
As of March 2020, the gross non-performing assets (Bad loans) of the banking sector was approximately 8.5% of the total advances. The pandemic and the national lockdown are likely to significantly push up bad loans for the banking sector.
'A stress test conducted by the Reserve Bank of India suggests that the Covid-19 crisis could push Indian banks’ gross bad loans to their highest in nearly two decades (record of 12.7% in March 2000).'
- Under the baseline scenario, the gross NPA ratio could rise to 12.5% by 2021. In a “very severe stressed scenario”, the gross non-performing assets of the banking sector could rise to as high as 14.7% of total loans by March 2021.
- Public sector banks could see their gross NPAs rise to 15.2% by March 2021 from 11.3% a year earlier in the baseline scenario. In the 'very severe stress' scenario, this could go as high as 16.3%.
- Under the baseline scenario, the system-level capital adequacy ratio could drop to 13.3% by March 2021 from 14.6% in March 2020.
- The Stress test was conducted on 53 banks in India. Results indicate that five of those banks may even fail to meet the minimum capital level by March 2021 in a very severe stress scenario.
- According to the conditions mentioned by the RBI in the stress test, India’s GDP could contract 4.4% under the baseline scenario. In the “very severe stressed” case, the contraction could be as high as 8.9%.
A look at the top private banks that have announced their recent quarterly results shows the increasing levels of provisioning they are undertaking expecting high NPA’s once the loan moratorium is lifted
A bank usually classifies loans that it gives to its customers broadly across 2 categories: Prime loans and subprime loans. Prime loans are loans given to high-quality customers with high credit scores and an efficient history of repayment. Subprime loans are of low quality and the probability of default is much higher than in prime loans.
Banks have sophisticated algorithms and models that predict expected defaults in the future. Banks, on the basis of the results of these models, provisions in its financial statements. The usual assumption is that a few percentages of the subprime loans and an extremely small percentage of prime loans will go defunct and the bank provisions for the same.
Bad loans impact the profitability of a bank, however for a large bank, as long as they can predict and manage the bad loans, they can continue their operations and honour their debt commitments. The real trouble comes when a bank’s prime loans start defaulting. This is something that banks usually don’t provision for.
The pandemic has massively affected almost every sector and business in the country. Many companies and individuals that were considered as prime by banks are facing financial troubles. We are witnessing banks and NBFC’s finding innovative ways to raise capital through the equity route. This indicates that banks are preparing for a storm to come.
MSME’s and construction are one of the worst affected. The contribution of MSMEs is nearly 30% of GDP, and 48% of exports. As per a report by CRISIL rating agency, about 70% of 40,000 companies have the cash to cover their employee cost for only 2 quarters.
Construction and housing infrastructure, historically proven to be a leading indicator of demand, consumption, and economic growth is arguably the second-largest employer after agriculture. The impact on this segment is huge is a massive understatement. The total exposure of lenders to construction and housing business is estimated at around Rs 7 lakh crore.
Roughly a third of the loans of private lenders and two-thirds of public sector banks are under the government moratorium. When the moratorium ends, EMI and loan repayments to banks will depend upon if the borrower still has a job and the businessman still has a business.
Invest only in high credit quality banks that have stable cash flows, sufficient liquidity to see the crisis through and an ethical management that is capable of handling a barrage of bad loans in the coming future. The investment might be through equity, bonds, fixed deposit etc, irrespective of the instrument the criteria should not change.
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