While highlighting the need for proactive building up of adequate capital for banks to withstand possible asset quality deterioration, the Reserve Bank of India (RBI) has warned that the gross non-performing assets (GNPAs) of scheduled commercial banks (SCBs) may escalate to 14.8% under a severe stress scenario.
In its financial stability report (FSR), the central bank says, "Macro stress tests incorporating the first advance estimates of gross domestic product (GDP) for 2020-21 released on 7 January 2021 indicate that the GNPA ratio of all SCBs may increase to 13.5% by September 2021 from 7.5% in September 2020 under the baseline scenario; the ratio may escalate to 14.8% under a severe stress scenario."
"These projections are indicative of the possible economic impairment latent in banks’ portfolios. Stress tests also indicate that SCBs have sufficient capital at the aggregate level even in the severe stress scenario but, at the individual bank level, several banks may fall below the regulatory minimum if stress aggravates to the severe scenario. The need of the hour is for banks to assess their respective stress situations and follow it up with measures to raise capital proactively," the report says.
According to the report, policy-induced easy liquidity and financing conditions in response to the COVID-19 pandemic enabled improvement in lending rates, profitability, and capital adequacy of banks with some moderation in balance sheet stress; however, bank credit has remained subdued.
It says, “Macro stress tests indicate a deterioration in SCBs’ asset quality and capital buffers as regulatory forbearances get wound down. Contagion risks have receded with the shrinking of the interbank market. In the non-bank space, dominant positions occupied by mutual funds and insurance companies as fund providers continued, with non-banking financial companies (NBFCs) and housing finance companies (HFCs) turning out to be the largest borrowers.”
The FSR says the capital to risk-weighted assets ratio (CRAR) of SCBs improved to 15.8% in September 2020 from 14.7% in March 2020, while their GNPA ratio declined to 7.5% from 8.4%, and the provision coverage ratio (PCR) improved to 72.4% from 66.2% over this period.
"Bank credit growth has remained subdued, with the moderation being broad-based across bank groups," RBI says, adding, "Performance parameters of banks have improved significantly, aided by regulatory dispensations extended in response to the COVID-19 pandemic."
"Bank credit growth, which had declined to 5.7% in 2019-20, remains sluggish; on the other hand, deposit growth has remained robust in the double digits, reflecting precautionary saving in the face of high uncertainty," the central bank says.
Return on assets (RoA) and return on equity (RoE) for SCBs have improved across all bank groups and capital to risk-weighted assets ratios (CRARs) improved by 110 bps over March 2020 levels to 15.8% in September 2020. GNPA and net NPA (NNPA) ratios, which were edging down from September 2019 levels, fell further to 7.5% and 2.1%, respectively, by September 2020. The overall provision coverage ratio (PCR) improved substantially to 72.4% from 66.2% over this period.
On the domestic front, RBI says, while policy measures have ensured the smooth functioning of markets and financial institutions, managing market volatility amidst rising spillovers has become challenging.
It says, "Movements in certain segments of the financial markets are not in sync with the developments in the real sector. Aggregate banking sector credit remained subdued, pointing to vestiges of risk aversion even as aggregate demand in the economy is mending and reviving. In particular, credit flows to the manufacturing sector have been lukewarm at a time when output of the sector is emerging out of a prolonged contraction."
"The focus of the policy efforts is shifting from provision of liquidity and guarantees to supporting growth – including consumption and investment. Although a recovery in economic activity from the lows of March and April 2020 is underway, it is far from being entrenched and output remains below pre-pandemic levels," the Report says.
According to RBI, SCBs continued to have the largest bilateral exposure in the Indian financial system in September 2020. As regards inter-sectoral exposures, asset management companies or mutual funds (AMC-MFs), followed by insurance companies, remained the most dominant fund providers in the system, while NBFCs were the biggest receivers of funds, followed by housing finance companies (HFCs).
"The continuing shrinking of the inter-bank market as well as better capital position of banks led to decline in risk levels due to contagion effects," RBI says.