Double whammy of mounting bad debts and pandemic hit is rattling India's banks

Analysts see loan defaults rising this year as companies hit by Covid-19 shutdowns go out of business

epa08274288 A person stands at a Yes Bank branch in New Delhi, India, 06 March 2020. ccording to media reports, the Reserve Bank of India (RBI) has seized control of India's Yes Bank and has caped withdrawal at 50,000 Indian rupee (678 US dollar) per account.  EPA/RAJAT GUPTA
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The impact of the coronavirus pandemic and the nationwide lockdown is raising concerns about the health of India's banking sector, which was wobbling under a mountain of bad debt even before the outbreak.

Analysts are now predicting a wave of loan defaults this year as companies go out of business because of pandemic-related shutdowns or struggle to service their debts amid reduced income.

“The economy is going through a very troubled time and I think we will see a lot more stress going forward,” says Jimeet Modi, founder and chief executive of Mumbai-based Samco Securities. “A lot of the stress will be contributed by small and medium-sized businesses and the banking and financial services sector. We expect a lot of SMEs will end up defaulting on their loan and interest repayments, which will create a vicious cycle and further difficulties for banks and non-banking financial companies.”

India's banking sector has been struggling with ever-increasing levels of bad loans, triggered by a series of defaults by corporations, individual clients, and other smaller businesses over the past few years.

Authorities had taken steps to strengthen the ailing banking sector and tighten lending practices in Asia's third-largest economy. These included mergers of state-run banks and placing several lenders on the watch list of the country's central bank – the Reserve Bank of India (RBI).

The aim was to help struggling institutions improve their balance sheets. However, despite corrective measures, India, with its $190 billion (Dh697.3bn) of bad loans, overtook Italy to become the major global economy with the worst non-performing loan ratio, according to Bloomberg, which cited data from the RBI.

Now, with the coronavirus pandemic hitting the global and local economy and a nationwide lockdown, which has been in place since March 25, it is inevitable that there will be more pain in store for the country's financial institutions, analysts and business leaders say.

“The banking sector already grappled with many issues including rising NPAs [non performing assets], a liquidity crunch and under-capitalisation,” says DK Aggarwal, the president of India's PHD Chamber of Commerce and Industry. “The onset of Covid-19 has further aggravated the issues and concerns for them as they may witness a hike in credit costs and limited disbursement of loans to various segments of economy.”

Some analysts say the slow progress made over the years to clean up India's banks could be derailed with the latest crisis.

“The pandemic has brought most businesses to a halt,” says George Alexander Muthoot, the managing director of Muthoot Finance, a Kerala-based gold financing company.

“Most people were forced to stay at home and demand for goods and services has dwindled. The banking sector has faced a certain amount of problems due to the credit crunch even before the pandemic [hit]. All businesses are [now] in the process of rewriting their business strategies.”

Prime Minister Narendra Mod's government last month unveiled a $266bn economic package, but economists say the stimulus is more focused on long-term measures, rather than putting cash directly into the hands of businesses. The government package also includes provision of credit for businesses, but that relies heavily on lending by state-run banks, and the government has yet to put money into those lenders.

Analysts agree that right now it is extremely difficult to estimate the impact on the banking sector given the ongoing uncertainty surrounding the pandemic. India reported 11,000 new Covid-19 cases in a single day on Saturday, brining the total in the country to more than 300,000. More than 8,800 deaths from the virus have also been reported according to the Johns Hopkins University, which is tracking its spread.

“I think no one knows the answer,” says Yuvraj Choudhary, a research analyst at Anand Rathi Securities in Mumbai. “Bankers, top management, even the customers themselves, they don't know what will be the end impact of this whole lockdown situation.”

In the case of some banks, 30 to 40 per cent of their customers have applied for moratoriums on their loans.

“These businesses may have applied for the moratorium out of financial distress or it may just be a precaution,” says Mr Choudhary. “There is a set of customers who have applied for moratoriums because their business is not doing well and that is a problem.”

In recent weeks, India has relaxed some restrictions that were part of its nationwide lockdown in a effort to revive the economy.

But many businesses have yet to reopen, and some that are open are struggling to get the labour they need after the vast majority of migrant workers fled cities to return to their home towns. Subdued consumer demand for all-but essential goods amid the pandemic is another factor hurting businesses.

Goldman Sachs expects India's GDP to contract by 5 per cent in the current financial year due to the pandemic. The economy could shrink by as much as 45 per cent in the April to June quarter, according to the investment bank.

With such a gloomy economic outlook, lenders are reluctant to start handing out loans to many sectors, which means that businesses will struggle to access much-needed credit, experts say.

“The Covid-19 and resultant lockdown has impacted the resilience of the banking sector in form of a liquidity crunch,”  says Mr Aggarwal. “Going ahead, prolonged financial sector weakness could weigh on credit growth, economic output and investment and productivity in the coming times. The health of banking sector is going to be worrisome if their lending activities are not boosted.”

"We expect a lot of SMEs will end up defaulting on their loan and interest repayments, which will create  a vicious cycle and further difficulties for banks and non-banking financial companies," says Jimeet Modi, founder and chief executive of Mumbai-based Samco Securities.

Mr Choudhary says that lenders are trying to be as prudent as possible. For example, pharmaceutical and fast-moving consumer goods sector companies are more likely to be able to secure loans than businesses in the travel and hospitality industries, which are the hardest hit by the pandemic.

The non-banking financial sector crisis that erupted in 2018 is another issue weighing heavy on banks. The extent of their troubles came to the fore with the collapse in March of India's fourth-largest private sector lender, Yes Bank, in March. The State Bank of India led a 100bn rupee (Dh4.87bn) bailout package to rescue the lender, which buckled under a heap of bad debts, when non-financial banking and real estate companies defaulted.

Analysts say in the current scenario more support will be needed from the authorities for the banking and broader financial services sector as India tries to revive its economy.

“Recapitalisation of banks will be required" to restore the balance sheets of under-pressure lenders, particularly publicly-owned banks, says Mr Aggarwal.

The RBI has already delivered two emergency interest rate cuts since the lockdown began and also announced measures to address liquidity constraints. But the help extended so far is not enough.

“I do believe the government will have to be ready to support public sector banks with capital,” said Uday Kotak, the  founder of Kotak Mahindra Bank, Bloomberg reported. “My advice to both private-sector banks and non-bank financial companies is: make yourself stronger, fortress your balance sheets. And if that means raising capital, go ahead and do it.”

Kotak Mahindra Bank has raised almost $1bn over the past few weeks through the sale of shares to boost its own balance sheet.

Work is also continuing to manage the long-term health of the sector.

On Thursday, the RBI proposed stricter governance rules for commercial banks. These proposals include limiting how long a major shareholder can serve as chief executive to 10 years, and drawing up clear divisions of responsibilities between a bank's board and management.

The RBI is also setting up an internal working group to review its guidelines on the ownership and governance structure of private sector banks.

In the near term, analysts say it is in the government and RBI's interest to do whatever it takes to support the banking sector through the pandemic.

“The financial sector is the heart of the economy,” says Mr Choudhary. “I don't think any of the banks in India will be allowed to fail.”