Stress on banks' balance sheets a serious threat to Modi's economic revival agenda

The amount of restructured loans on the book of Indian banks continued to rise in the three months ended 30 September as more number of companies became stressed units and failed to honour their repayment obligations to lenders.

In the September quarter, banks approved Rs 19,105 crore of fresh loans for restructuring from 19 companies under the corporate debt restructuring mechanism (CDR), a forum of lenders, which offer relaxed loan repayment terms to troubled companies by slashing lending rates, offering a moratorium and extending the loan repayment period, according to official data.

Total number of cases referred for loan recast under CDR in the June-September period stood at Rs 13,313 crore from 14 companies.

As against this, in the June quarter, banks had approved 10 cases worth Rs 18,000 crore in the CDR, while references stood at Rs 2,854 crore from just two cases.

But that’s partly due to excess caution from banks after new provisioning norms on restructured loans came into effect. One of the major cases in the September quarter was Tecpro Systems, which restructured between Rs 5,000 and Rs 6000 crore worth of loans.

To be sure, restructured loans are not bad loans, but surely can be termed as loans that have high probability of default in the event of further deterioration in the macro-economic scenario. A weak economy would mean less economic activities and more pressure on the balance sheets of companies.

Even on the bad loan front, the picture is not so promising for those state-run banks, which announced September quarter results, so far.

The three state-run banks (State Bank of Mysore, Punjab National Bank and Oriental Bank of Commerce), which have announced earnings so far have reported a total of Rs 29,915 crore gross non-performing assets (NPAs) in the second quarter compared with Rs 28,076 crore in the preceding quarter.

More clarity on the bad loan scenario will emerge only after other leading banks announce their earnings. In the June quarter, the total gross NPAs of banks stood at about Rs 2.5 lakh crore, majority of which emerged from the books of public sector banks.

Total stressed assets in the banking system (bad loans combined with restructured loans) amounts to 14 percent of the total loans given by the banking system at end-June.

Continuous rise in the stressed assets and simultaneous slowdown in the credit outflow of banks underlines the fact that economic revival is yet to take strong hold at the ground level. Bank credit growth stood at mere 4.6 percent in the fiscal year so far, compared with 7.4 percent in the previous fiscal year.

What is more important and disturbing is that the credit flow to industries, especially medium-sized companies, which are the backbone of an emerging economy, has remained stagnant so far this fiscal year, which indicates prolonged slowdown in the economy.

Majority of the Indian industries still heavily depend on bank loans to run their businesses and not private capital like in the cases of top-rated corporate houses. Hence, absence of credit flow impacts their financial health almost immediately. Bankers, on the other hand, blame absence of new projects for slowing credit growth.

The optimism in the economy post the arrival of a stable government at the Centre still doesn’t seem to have much influence on changing the fortunes of industries and banking sector so far. On the other hand, increase in the bad and restructured loan levels of banks necessitates more capital in these banks, adding to the burden of the government fighting a large deficit.

On Wednesday, international rating agency Moody’s retained its negative outlook on the domestic banking system, citing high leverage in the corporate sector that may prevent any meaningful recovery in asset quality.

“Our outlook for the country’s banking system remains negative, as it has been since November 2011. The negative outlook reflects our view that high leverage in the corporate sector could prevent any meaningful recovery in asset quality, notwithstanding a moderate rebound in economic growth,” the agency Moody’s Investors Service said.

According to the rating agency, continuing poor asset quality, wherein the NPAs levels are set to touch 4.5 percent of the system, will require continued provisioning and strengthened capital buffers.

On Tuesday, Standard & Poor’s too said India’s plan to grant new banking licences to companies could increase risks in the banking sector given the chance that new entrants could be lax about loan standards to garner business.

The agency’s warning came at a time when the RBI is set to come out with new types of banks and plans to introduce continuous full-service bank licensing.

“The sector’s stability or risk appetite could be hit if any of the new players relax their underwriting standards or undercut prices to gain market share,” S&P said.

That apart, the rating agency also highlighted the risks from a prolonged weakness in Indian banks’ asset quality, which could hurt economic recovery. The rater expects gross non-performing loans to rise to 4.5 percent by the end of March 2015 from 4 percent in the previous year.

The message: It is highly critical for the Modi-government to address the deterioration in the financial health of companies and, in turn, that of banks, if it is serious about what it preaches i.e. breathing life back into a weak economy that has grown at sub-5 percent levels in recent years.

If not, the damage can be more than what it possibly anticipates now.