Banking Health: NPAs and COVID-19

ECONOMY/ GOVERNANCE

Topic: General Studies 3:

• Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment. 
• Monetary Policy

Banking Health: NPAs and COVID-19

Context: The data on gross non-performing assets (GNPA) has fallen from 11.5% in March 2018 to 7.5% of outstanding loans by September 2020. 

What Is a Non-Performing Asset (NPA)?

• A nonperforming asset (NPA) refers to a classification for loans or advances that are in default or in arrears. 
• A loan is in arrears when principal or interest payments are late or missed. 
• A loan is in default when the lender considers the loan agreement to be broken and the debtor is unable to meet his obligations.
• In India, a non performing asset (NPA) is defined as a loan or advance for which the principal or interest payment remained overdue for a period of 90 days

Why NPA resolution is crucial for the economy?

Simply put, banks’ ability to lend is critical for businesses and the economy to grow. A deluge of bad loans (i.e. NPAs) impairs banks’ ability and willingness to lend that furthers impairs the growth prospects of economy.

Improvement of Banking Health in recent quarters

• Private Sector Profitable: After losses in two consecutive years, India’s scheduled commercial banks turned profitable in 2019-20. 
• PSB losses reduced: However, State-run banks continued to bleed for the fifth year in a row, but their losses were much more stifled. 
• Impact of Policies: The RBI attributed this to the resolution of a few large accounts through the introduction of the Insolvency and Bankruptcy Code (IBC) in 2016, and fresh slippages in loan accounts dipping to just 0.74%.

Genesis of the NPA Problem

• Boom years of late 2000s: A large part of the problem started in the latter half of 2010s, as assumptions of persistently high economic growth made several large corporates overzealous in their investment ambitions, thus over-leveraging themselves in the process. 
• Role of Easy Credit by Banks: On the prospects of high economic growth financial sector, led by public sector banks, fuelled these expansion plans through easy money on credit.
• 2008 Financial Crisis: Growth (and demand) fizzled out following the global financial crisis of 2008. Despite the fire-fighting measures taken by government, the impact of the global crisis was felt in coming years. The crisis got further precipitated by Policy Paralysis of UPA-2 government (Corruption Scandals, Coalition Politics, standstill bureaucracy)
• Vicious cycle: The stress from stretched corporate balance sheets (revenue impacted due to slowdown) infected banks’ own books and underwhelmed banks own capacity for fresh lending. Former Chief Economic Adviser Arvind Subramanian had called it India’s ‘twin balance sheet problem’ in the Economic Survey for 2016-17.
• Peak reached in 2018: Over the course of 2014-19, India’s banks were put on high alert by RBI for tighter recognition norms for bad loans. As a result, in March 2018, when bad loans on their books peaked to over ₹10 lakh crore — around 11.5% of all loans.
• Policy Measures to stem the problem: The vicious cycle of twin balance sheet problem was interrupted to an extent by the IBC, which, along with tighter recognition norms for bad loans, helped correct the course over time.

COVID-19 should have further worsened NPA problem right?

The reason bad loans and insolvency proceedings have not surged as multiple businesses went kaput, taking millions of employees with outstanding retail loans down with them, is because of steps taken by government

• Regulatory forbearance steps taken by authorities: Interest rates were cut after the onset of the pandemic, a moratorium was offered on loan instalments due from borrowers, and liquidity was infused into the system to keep the wheels of the economy moving without a further shock

• Suspension of IBC: At the same time, the invocation of the IBC was suspended for loans that went into default on or after March 25, when the lockdown began. While this suspension has now been stretched till March 31, 2021, a loan restructuring window for borrowers was closed in December 2020.
• Support to Stressed Sectors: Government under its Atmanirbhar package provided credit flows to some productive and COVID-19-stressed sectors (ex: Production Linked Incentive Scheme)

A decline in bad loans is good news. But is it the real picture?

• Economic Slowdown before Pandemic: The problem is that the COVID-19 pandemic and the national lockdown upended businesses and revenue models across industries, just as it did in the rest of the world. But unlike most of its peers, India’s economy had been declining sharply even before the emergence of the virus.
• Inadequate Support: Despite all this, life support in the form of adequate credit flows to some productive and COVID-19-stressed sectors has been deficient, the central bank has said. 
• True Picture will emerge when support measures are rolled back: RBI believes that a real picture of the state of borrowers’ accounts (and consequently, the banking system in general, and the economy at large), will emerge once the policy support measures are rolled back. Had the central bank’s normal loan classification norms been followed instead of the COVID-19 relief measures, bad loans would have been higher, the RBI has argued
• Housing Finance Sector may drive NPAs in Future: RBI has also warned about large-scale loan defaults looming over housing finance companies, which have been hit by delays in completion of housing projects, cost overruns due to reverse migration of labourers, and delayed investments by buyers in the affordable housing sector as incomes shrank and jobs were lost.

What measures has RBI recommended to deal with future challenges?

To make the banking sector healthy in the face of large-scale delinquencies and balance-sheet stress that the ravages of the pandemic leave behind, it is critical to

• Rewind various relaxations in a timely manner”, 
• Rein in loan impairment 
• Ensure adequate capital infusion into banks
• Experts say more taxpayer money may be needed to shore up public sector banks.

Conclusion

• For now, as the central bank has said, the restoration of the health of banking and non-banking financial sectors depends on the revival of the real economy and how quickly the animal spirits of entrepreneurship return.
• The Union Budget for 2021-22, which is now just four weeks away, would be critical for banks on two fronts – in what it does to revive demand and investments, and how much money it can promise to set aside for recapitalising public sector banks in the coming year.

Conclusion

• Atmanirbhar Package
• N.K.Singh Panel on FRBM Act