A judgment by India's Supreme Court allowing local banks to resume classifying delinquent accounts as nonperforming assets will likely help lenders repair their balance sheets more quickly, although another round of steep provisioning is unlikely as most banks have set aside sufficient buffers for those at-risk borrowers in recent quarters, analysts say.
The top court's March 23 decision was a reversal of a ban that has been in place since September 2020 that aimed at containing potential loan defaults due to the blow to the economy from the COVID-19 pandemic. Despite the ban, most banks, especially private-sector lenders, made provisions for defaulting accounts in the December 2020 quarter, marking them as "pro forma" nonperforming assets instead of officially declaring them nonperforming.
"Now, we will start seeing banks start taking bold steps towards the recovery process" of their bad loans, Siddharth Purohit, an analyst at SMC Global Securities, told S&P Global Market Intelligence. "As long as you don't classify as NPL, you can't start recovery. It will be normal operations for banks now."
Following the court order, banks will start reporting actual NPAs, instead of pro forma bad loans, he said. "It won't be materially big to change the [profit and loss account] for most banks."
India's central bank said in January that its stress tests show the gross NPA ratio of the entire banking system could rise to 13.5% by September from 7.5% a year earlier. If the macroeconomic environment worsens into a severe stress scenario, the ratio could surge to 14.8%, the Reserve Bank of India said in its biannual Financial Stability Report published Jan. 11. Masked by the top court's previous order, NPAs had been on a declining trend through the December quarter despite the pandemic.
"Now it will become easier for banks, and even for investors. Banks can decide which loans to recover, which to write off and which to ignore," Purohit said.
Pro forma NPAs
The pro forma NPAs reported by banks was about 150 basis points higher than the reported NPAs in the fiscal third quarter that ended in December 2020, indicating formation of fresh bad loans in the period, Jefferies said in a March 23 note for clients. However, most lenders have built "reasonable contingency provision," Jefferies said.
For example, the adjusted contingency provision after taking into account the pro forma NPAs by ICICI Bank Ltd. was 1.1%, HDFC Bank Ltd. 0.7% and State Bank of India 0.3%, in the December quarter, according to the report.
The court also ordered that borrowers not be charged the interest due on interest for the six-month moratorium on repayments allowed by the government in 2020 as part of its pandemic relief measures. The government had announced in October 2020 that it would bear the cost for loans up to 20 million rupees and several pleas seeking the same relief were filed by borrowers with loans exceeding that amount. The court judgment extended that relief to all borrowers but did not say who would pick up the tab, estimated at about 50 billion rupees by ICICI Securities.
The additional burden, estimated at 12 billion rupees on private-sector banks, 28 billion for state-run lenders and the rest on nonbanking financial institutions and housing finance companies, may be a drag of less than 4 basis points on the return on assets for all lenders, ICICI Securities said March 24.
The verdict "settles the uncertainty long lingering on the plea to waive the interest," ICICI Securities analysts wrote in the report. "Though delayed, the judgment is welcome in spirit as it limits scope for judicial review of economic policy decisions, and probably sets a reference for such cases in the future," according to the report.
As of March 24, US$1 was equivalent to 72.57 Indian rupees.