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India's central bank expects bad loans to surge due to COVID-19

Indian commercial banks could see a surge of bad loans as the novel coronavirus pandemic continues to batter the economy, reversing improvements in the sector's health in recent quarters, according to stress tests by the central bank.

The gross nonperforming asset ratio of local commercial banks may rise to 12.5% by March 2021, from 8.5% in March, under the Reserve Bank of India's baseline scenario. A further deterioration in the macroeconomic environment may push the ratio as high as 14.7% under a "very severely stressed scenario."

"The outlook remains clouded with considerable uncertainty as the pandemic takes its toll," the RBI said in its half-yearly Financial Stability Report released July 24.

In its report, the central bank noted that the overhang of stressed assets continued up to the early part of the last fiscal year that ended in March, due to a prolonged slowdown in global and domestic growth that dragged on credit demand. This culminated in the lenders' gross NPA ratio hitting a recent peak of 9.3% in September.

Slippage ratios, which measure new accretions to NPAs as a ratio to advances, then receded, resulting in the provision coverage ratio of banks improving to 65.4% in March from 61.6% in September 2019. The NPA provisions for state-owned banks and foreign banks were also decelerating since March 2019.

However, the central bank said that "towards the close of the financial year, these slow moving improvements were overwhelmed and halted by the outbreak of COVID-19."

More capital may be needed

The central bank has since allowed borrowers to seek a moratorium on their debt repayments till Aug. 31 and slashed interest rates, as Indian authorities seek to cushion the impact of the outbreak. The federal government also announced a 20 trillion Indian rupee relief package, which included greater liquidity support and higher government investment in building rural infrastructure to generate employment. Still, most analysts expect the nation's economy to contract in 2020, logging its worst performance in the last four decades.

The RBI report "points to a sharp increase in stress because of the pandemic. The stress projection incorporates elevated slippages from the pool of loans already under moratorium," said Sameer Narang, the chief economist at state-owned Bank of Baroda.

Nearly half of the total systemwide loans were under moratorium as of April 30, according to the RBI. The proportion of loans under moratorium for state-owned and private banks were roughly 68% and 31%, respectively.

During the last fiscal year, "banks were already risk-averse, with majority of incremental credit flow going to public sector undertakings and highly-rated private corporates," Jefferies said, adding the trend is likely to have continued into the current financial year.

Still, the gross NPAs of state-run banks may rise to 15.2% by March 2021 from 11.3% at end-March, under the baseline scenario in the RBI's stress tests. The gross NPAs of private sector banks may rise to 7.3% from 4.2%, and those for foreign banks may edge higher to 3.9% from 2.3%.

Under the RBI's very severe stress scenario, the capital to risk-weighted assets ratio for Indian banks may drop to 11.8%, and five banks may fail to meet the minimum capital level by March 2021 under the RBI's very severe stress scenario. The system-wide CRAR was at 14.6% at end-March, it said. The common equity Tier I capital ratio for Indian banks may also dip to as low as 9.4% from 11.7% in March, and three banks may fail to meet the minimum regulatory CET1 capital ratio of 5.5%. The central bank did not identify the banks that could be affected.

The RBI said it was still early to accurately assess the effects of the moratorium on the banks' asset quality as it is still uncertain and evolving. However, "the banking system may need to augment its capital to cater to a post-COVID-19 revival in the economy," it said.

As of July 24, US$1 was equivalent to 74.75 Indian rupees.