In these uncertain times, the banking sector needs careful tracking. Seemingly, banks are virtually exempt from the lockdown, and are operational as customers continue to make banking transactions. Almost all policies implemented to aid relief operations involve banks, making them the nucleus of the welfare package. Yet, this onus makes them more vulnerable than any other entity.
The issue of moratorium on loan repayments is crucial. While the idea is to make it easier for firms to service debts during the shutdown, and to enable individuals to still make repayments despite layoffs or salary cuts, banks will face a problem of choosing which accounts to consider for the moratorium. Since the clause allows deferment, and not waiving, of payments, it is important to think carefully before opting for the moratorium. Borrowers may have an incentive to deliberately delay payments, which can increase the bandwidth of banks once the moratorium lifts.
Relatedly, there can be extensions of the moratorium if the shutdown gets extended. Further, even after the moratorium ends, the probability of borrowers defaulting will be high—a major worry for banks. Post the NPA crisis, banks have focused more on extending loans to the retail segment as well as to SMEs, with strong nudging by the government. These two segments are expected to witness significant increase in NPAs in the current crisis, as larger companies are better insulated against the ongoing economic slowdown.
Also, the first package the government announced increased the threshold for default by companies under IBC from Rs 1 lakh to Rs 1 crore to prevent the triggering of insolvency proceedings against MSMEs. For banks, this means greater monitoring work, reworking the asset classification and provisioning norms, as well as capital adequacy.
These measures definitely favour borrowers. But, banks run the risk of disruption to their books as they rework all their policies and numbers for the first three months, and take reverse action post the extension, which will throw up a fresh set of numbers. Thus, there is reason to believe that NPAs may increase once again after this exercise, and the March numbers, based on the new recognition norms, might understate the situation. RBI’s latest FSR has highlighted that incremental NPAs have actually come down, and most of the stock was due to recognition of past assets, not new ones. This matrix will change.
Banks are tasked with enhancing flow of credit to the commercial sector, and lowering interest rates. RBI has created an enabling environment for this, and will expect banks to match the repo rate cut with lower MCLR. The small savings rates have been cut quite drastically, nudging banks to lower deposit rates too. This may be expected to follow, with banks lowering their lending rates, though not to the extent of the reduction in small savings rate, and will also be short of the repo rate change.
There is, however, a possibility of deposits being impacted by multiple factors. First, household incomes would be lower due to layoffs and pay cuts by several companies. Certain state governments have also announced pay cuts for their employees, which will reduce overall consumption, and ability to save. With food inflation already showing signs of increasing, the incremental flow of deposits could be impacted.
Second, lowering of deposits rates will incentivise households to venture into the capital market, which has attractive valuations given the decline by over 30% in the last fortnight or so. While the more suave might go for equity, mutual funds look relatively more attractive, and safe, under these conditions.
It must be pointed out that the government, too, is likely to opt-in for a large borrowing programme, which might go beyond Rs 7.8 lakh crore. This is for three reasons. First, the welfare package of Rs 1.7 lakh crore will be equivalent to 0.75% of GDP. Second, it is certain that tax collections will be lower this year due to the shutdown, and the slowdown that will follow. GST collections will be lower due to consumption being affected, while corporate distress will manifest in low or negative profits and, therefore, tax payments. Third, the government has drastically cut the small savings rate, which logically makes them less attractive. Now, the NSSF has been an important source of funding for the government, and in FY20 and FY21, have been placed at Rs 2.4 lakh crore. In case this reservoir dips, which will happen when incremental inflows slow down, the government, per force, will have to borrow from the market, and the gross borrowing programme will be exceeded.
This is where the conundrum arises. Banks and FIs are large subscribers to government bonds, and for an enlarged programme to be successful, sufficient funds will be needed. Today, liquidity is high due to low offtake in credit. In FY21, there will be opposing forces. Bank credit will be growing at a faster rate as banks rework the working capital limits of borrowers. Also, those in distress will require funding, making the growth rate much higher than that in FY20. The government will be borrowing more for the reasons stated above. And, finally, growth in deposits would slow down. In this eventuality, it will be like FY19 again, where there has to be substantial RBI intervention. RBI has already opened its armoury through LTROs at a time when there was surplus liquidity to quell interest rates. This time, it will have to support government borrowing (states, too, will probably borrow more in the market). All this means that there will be too much money spent, leading to higher inflation in the medium term.
This will have a bearing on future monetary policy decisions as the comfort of low CPI inflation will be a thing of the past. This happened post the financial crisis in 2008, and will be repeated with greater momentum this time. This will be one of the biggest costs of the pandemic to India, which may not get reflected in the GDP growth number (UN believes India and China will be the outliers). And, the banking sector will have to be prepared for an NPA replay.
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