Retail MSMEs and NPAs could increase as relief measures end

The Reserve Bank of India warned on Thursday that banks face the prospect of an increase in NPLs, especially in their small and medium-sized enterprises (SMEs) and retail portfolios, especially as the regulatory relief is deleted.

The last of the RBI Financial Stability Report (FSR) noted that banks have remained relatively untouched by the disruption induced by the pandemic, cushioned by regulatory, monetary and fiscal policies.

The report reflects the collective assessment of the Financial Stability and Development Board (FSDC-SC) Sub-Committee on Financial Stability Risks.

“Within the national financial system, bank credit flows and corporate capital spending remain modest.

“As banks’ exposures to larger, higher-rated borrowers decline, there are emerging signs of tensions in the micro, small and medium-sized enterprises (MSMEs) and retail segments,” the report said.

The FSR pointed out that demand for consumer credit from banks and non-bank financial corporations (NBFCs) has slowed, with some deterioration in the risk profile of retail borrowers becoming evident. Moderate credit growth in a low interest rate scenario could impact banks’ net interest income levels, he warned.

Stable APN ratios

Banks’ gross and net NPA ratios remained stable during the second half of 2020-2021, at 7.5% and 2.4%, respectively, in March 2021. At end-September 2020, the ratios were 7.5% and 2.1 percent, respectively.

On the flip side, Special Mention Account (SMA) ratios, which reflect an onset of stress, have deteriorated, according to the report.

The report says banks need to prepare contingency strategies to deal with segment-specific asset quality pressures, especially when regulatory reliefs are reversed.

According to the FSR, macro stress tests for credit risk show that the GNPA ratio of programmed commercial banks could drop from 7.48% in March 2021 to 9.80% by March 2022 in the baseline scenario and to 11.22% in a severe stress scenario.

Stress tests also indicate that SCBs have sufficient equity capital, both at aggregate and individual level, even in the severe stress scenario.

Monitor MSMEs, personal loans

As banks and other financial institutions have resilient capital and liquidity buffers, strains on balance sheets remain moderate despite the pandemic, according to the report. But he emphasized close monitoring of MSMEs and individuals’ credit portfolios. This calls for banks to consolidate their capital when favorable market conditions prevail, he added.

“The banking sector will have to protect itself specifically against adverse selection bias while being attentive to the demand for credit from productive and viable sectors.

“In the most optimistic scenario, the impact of the second wave is expected to be contained in the first quarter of the year, while frictional inflationary pressures subside during the first half,” the FSR said. The report says financial intermediaries need to internalize these expectations into their outlook while remaining on guard against potential strains on the balance sheet with sufficient capital and liquidity cushions and governance structures.

Government loans

Referring to the surge in government borrowing in the market, with a significant share of public debt absorbed by banks, the FSR noted that in the future, however, their absorption capacity may be limited by the likely expansion of bank credit as the economy recovers.

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