COVID-19 has emerged as the black swan event of the 21st century, with the significant macro-economic impact on both levels (Global and National). Because of COVID-19 non-linear spread and lack of textbook solutions to deal with it the shock of COVID-19 on the global economy and Indian economy is unprecedented. There are two causes behind this scenario. The first cause is the global slowdown and trade disruptions, with sectors such as textiles, automobile parts and components, and steel taking a direct hit in their revenue growth due to volumes and realisations are under pressure and the second cause is the nationwide lockdown and social distancing, driving factory closures, reduced labour wage growth, travel bans, and decreased retail consumption. This has mainly influenced sectors such as retailers, airport operators, hospitality & tourism, and roads. The second cause may also include a liquidity crunch besides reduced domestic consumption. In this uncharted territory, while many have declared this situation as a global recession, quantifying the impact on demand across sectors beyond the prediction of de-growth is still a big challenge. What we know so far is that the impact of COVID-19 will be large and can potentially push down the GDP growth to a negative zone. All this would mean that banks are up for a major shock in the post-COVID world as the tumbling economy will have a spiralling effect on Banks NPA.

The GDP slowdown due to the COVID-19 outbreak will aggravate the stress and slippages in the non-corporate segments like retail, agriculture and micro, small and medium enterprises (MSMEs). On the basis of assets quality, the largest segment of home loans will be less affected because more than two-thirds of the borrowers of home loans are salaried and their repayments are also based on auto-debit instructions. In contrast, the affordable housing loans could witness an increase in loan defaults over the medium term because of most of the borrowers are self-employed, whose income streams have been affected more by the lockdown. However, the strong moral obligation linked with the residential property will be helpful to keep the whole asset quality in control. The second-largest asset class is vehicle finance and it would also face immediate challenges in collections of repayments due to the lack of proper movement of goods (other than essentials). Overall, the vehicle finance segment has a strong correlation with a pickup in economic activity. In terms of the MSME sector, the lockdown is expected to result in a high impact on the collection of loans because most of the establishments have faced significant disruption in business. The impact on their cash flows could remain high even after lockdown restrictions are fully lifted because many of them may scramble not just with how economic activity picks up, but also with business-specific supply chain problems and counterparty debtor risk across the value chain.

Credit offtake by the corporate sector is expected to remain unchanged. The retail segment, which has contributed to banking sector credit growth in recent years, should also be subdued until the economy does not get back on track again. Credit growth of scheduled commercial banks (SCBs), which had continuously weakened during the first half of 2019-20, slid down further to 5.9 per cent by March 2020 and remained unchanged up to early June 2020. The government initiatives which was taken before lockdown for the revival of economic condition should spur the credit demand. Speed of revival and pace of economic recovery will play an important role in how fundamental asset quality pans out. This is not only applicable for large enterprises but will also have an impact down the chain for micro, small and medium enterprises (MSMEs) and retail customers. Banking sector profitability in the fiscal year 2021 will be mainly dependent on how asset quality and provisioning costs pan out. With the slower credit growth, the pre-provisioning operating profits would be impacted reducing the cushion to absorb credit costs. In this context, the ability to control operating expenses will gain importance in managing profitability.

To measure the severity of the impact we have collected the projections/ predictions made by different analysts. According to the rating agency Crisil report, in this fiscal, there has a rise of 150-200 basis points (bps) in the gross non-performing assets (NPAs) of lending institutions due to higher slippage and lower recovery. Crisil has projected GNPAs in the range of 11%-11.5% for the fiscal year 2021. Reports also suggest that around one-third of industrial and service firms have applied for moratoria on their bank loans. If only a quarter of these deferred loans eventually go bad, then the nonperforming assets (NPAs) would dramatically increase by Rs 5 lakh crore.

According to the India rating agency, COVID-19 may drive total slippages of banks by up to Rs 5.5 lakh crore in this financial year. The banking system is already burdened with the total of Rs 8 lakh crore worth of NPAs. Due to disruptions caused by coronavirus pandemic the Gross non-performing assets (NPAs) of banks are likely to worsen from 8.6% as of March 2020 to 11.3%-11.6% by the end of this fiscal year.

According to the rating agency ICRA Report, new gross slippages are estimated to be in the range of 5%-5.5% of standard advances during 2020-21, which will increase the banks’ credit provision and also impact their earnings. The credit provisions will continue to exceed the operating profits for the public sector banks (PSBs) during 2020-21, translating in a sixth consecutive year of loss.

As per the Ind-Ra rating agency, the corporate slippages in FY20-21 would increase to Rs3.4 trillion. Based on Ind-Ra’s vulnerability framework and corporate stress analysis of 30,000 corporates, the total corporate standard-but-stressed corporate pool may increase from 3.8% of the total bank credit as of December (pre-COVID-19 levels) 2019 to up to 6.6% under Ind-Ra’s post-COVID-19 corporate stress case. The incremental stress is mainly from sectors including power, infrastructure, constructions, hospitality, iron & steel, telecom and realty. The rating agency expects about 40% of the incremental slippages could come from the non-corporate segments.

Reserve Bank in its 21st Issue of the Financial Stability Report (FSR), which reflects the collective assessment of the Sub-Committee of the Financial Stability and Development Council (FSDC) on risks to financial stability, and the resilience of the financial system in the context of contemporaneous issues relating to development and regulation of the financial sector has observed that:-

The capital to risk-weighted assets ratio (CRAR) of Scheduled Commercial Banks (SCBs) come down to 14.8% in March 2020 from 15.0% in September 2019 while their gross non-performing asset (GNPA) ratio declined to 8.5 per cent from 9.3 per cent and the provision coverage ratio (PCR) improved to 65.4% from 61.6% over this period. Macro stress tests for credit risk indicate that the GNPA ratio of all SCBs may increase from 8.5% in March 2020 to 12.5% by March 2021 under the baseline scenario; the ratio may increase to 14.7% under a very severely stressed scenario.

Though there may be some divergence in the predicted and actual figures, there is nothing to denying the fact that the situation is critical on the economic front. The measures announced by the Indian government as a part of an economic package are mid- to long-term measures; if these are implemented in a proper time frame, it could aid materially to reduce the predicted stress in micro, small and medium enterprises (MSMEs). Further, in these circumstances whether none of the sectors has such a strong ability to bear a loss, it becomes important to minimise the size of that loss. This can be done in two ways first, by preventing them from bankruptcies. To do so, banks will have to identify those firms which are viable and lend them the funds if they need, to overcome from the immediate crisis. But at the same time, banks are also facing their own difficulties, and are not able to bear the risk of making such loans. So it becomes necessary for the government to create a guarantee fund to support these lending. Second, when firms default their loans, they need to be resolved as soon as possible. Speed is a necessity of the current time because the financial position of stressed firms tends to worsen over time. While public attention focuses on the size of the NPAs, a much more important number is the recovery rate — the degree to which the banks can recover on these loans. And the only way to maximise the recovery rate is to sort out the bad loans speedily. If this can be done, and firms put back on their feet quickly, the economy will reap an additional benefit, since the resolved firms will be able to contribute to the recovery.

In the foreword of 21st issue of financial stability reports, RBI Governor Sh. Shaktikanta Das has also remarked “The challenges that lie ahead have to be addressed with the overarching objective of preserving long term stability of the financial system, which is critical for nurturing the recovery. Going forward, once we enter the post-pandemic phase, the focus would be on the calibrated unwinding of regulatory and other dispensations. Financial intermediaries will have to undertake reappraisal of their business models. Asset markets have to adapt to a new normal in a non-disruptive manner. Contagion risks warrant constant vigilance by all stakeholders in the financial system. The financial system in India remains sound; nonetheless, in the current environment, the need for financial intermediaries to proactively augment capital and improve their resilience has acquired top priority. In the evolving milieu, while risk management has to be prudent, extreme risk aversion would have adverse outcomes for all. In the period of social distancing, information technology platforms have worked well and these gains need to be consolidated. There is no room for complacency on cybersecurity. Financial sector stability is a prerequisite for giving confidence to businesses, investors and consumers. We need to remain extremely watchful and focused.”

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