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The negative economic impact of COVID-19 will lead to increased defaults by borrowers – Indian banks are in for Rs. 20 trillion hole

Unlike the other central bank governor who tried to stay tight-lipped during this health crisis, the Governor of Reserve Bank of India, Shaktikanta Das, utilizes this time by putting together some thoughts regarding the improvement of private and public banks post-pandemic in his latest speech.

At the banking conclave last weekend, he said that due to the impact of a pandemic on the economy – it may result in higher Non-performing assets (NPAs) and capital erosions of banks. Therefore, the recapitalization for the public and private banks becomes essential.

However, Recapitalization needs more money needs to be invested to keep the system going. There is already enough evidence with the increase in pressure at the banking system in the days ahead and of the upcoming storm.

In layman language, the negative economic impact due to coronavirus may lead to increased defaults by borrowers. Imagine if this will be the situation, How bad it can get?

Suppose, if the one-twentieth of the loans which is under the moratorium as of 31st August default. The overall amount of bad loans in the Indian banking system may reach to Rs.12 trillion. If one-fifth of the loans are lifted, then it could double the current level, up to the overall quantum of bad loans to Rs. 20 trillion. Of course, these are traditional estimates.

According to the Investment Information and Credit Rating Agency of India Limited (ICRA), 52% of assets are under NBFCs (Non-Banking Financial Corporation) which is under the moratorium as of May 2020. Only if 10% of these will default, it would directly double the gross NPAs under NBFCs and will reach 9.6% loans as of March 2021 which were supposed to be 4.6% as of March 2020.

[gross NPAs are also known as bad loans, the loans which have not been repaid for 90 days or more]

Any troubles faced by NBFCs are likely to be faced by banks as well. At the time of demonetization, banks had a surplus of money coming in as deposits. Banks lending NBFCs money stood at Rs. 3.22 trillion as of December 2016. By May 2020, the lending amount has jumped to Rs. 8.4 trillion. Hence, if NBFCs default, it will be difficult for them to repay bank loans.

Due to the pandemic, around 5.58 million salaried individuals withdrew the money from their Employee’s Provident Fund (EPF) because of a fall in their incomes. Many people are no longer in their position to continue paying their loans they have taken from banks or NBFCs. The only reason they haven’t start exploding is that until 31 august, they can opt to moratorium but September onwards the default will start exploding.

While private banks have started new recruitment for their loan recovery sections to handle an increase in the retail default loans. The trouble is more on the unsecured lending funds such as credit card outstanding, personal loans, consumer durable loans, etc.

As lockdown started in the late march, the bad loans must be piled up till now. But thanks to Moratorium! This didn’t happen. The bad loans will categories 90 days after 31 August, that is, 1 December onwards. In public sector banks, the loans booked under Moratorium is about 40-50%, whereas Mid-sized private bank have about 50% and large-size private banks are relatively lower to about 20-30%.

It can be safely assumed that half of the bank loans will be under Moratorium by 31 August. The remaining half is needed to be converted. But to put loan under moratorium comes with a cost. The interest due for the period will be added to Principal outstanding and borrowers, which in turn individual will have to repay a higher amount.

Hence, the borrowers who will be able to pay such amount should opt to move to the moratorium.

Given the circumstances, the chances that the number of defaults is high.

The rescue plan

India has been dealing with massive bank problems regarding bad loans from the last decade. As of March 2018, the bad loans amounted to Rs. 10.36 trillion. The bad loans as of March 2020 amounts to Rs. 9.4 trillion, that is, bad loans rate at 9.4%. Supposedly, if 20% of the bad loans under moratorium get defaults, the Rs. 10.2 trillion will be added to Rs. 9.4 trillion, which Rs. 20 trillion or 20% of the banking loans. If 5% of loans get defaulted, it will amount to Rs. 12 trillion or bad loan rate of 12%.

Given the scenario of the Indian banking sector, it is important to come up with some plans. That is why, RBI Governor Das, is already talking about recapitalization. However, some biggest private banks are already in the process to raise more capital.

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