Policy to deal with NPAs, and the passage of FRDI Bill, will shape sector in 2018

Banks had to go through the mill in 2017. Bad loans, and provisions towards them, dented the balance sheets of most public sector banks (PSBs) and a few large private sector banks. Also, the RBI imposed regulatory sanctions under the prompt corrective action (PCA) framework on a host of stressed PSBs, with restrictions being placed on their management and activities, to ensure that they are nursed back to health.

All this happened amidst credit growth hitting multi-year lows. This in turn magnified the bad loans problem.

Surplus liquidity due to huge deposit accumulation during the demonetisation period, coupled with a lack of credit appetite for most part of the year, triggered deposit and lending rate cuts without the central bank having to do much by way of rate cuts. Retail term deposits of over one year duration declined by about 50 basis points.

Fall in lending rates

The fall in lending rates (which declined almost 100 basis points), however, held no lure for corporates as they were still grappling with excess capacities. Those in a position to borrow, especially in the blue chip category, resorted to the bond markets.

As large and mid corporate loans continued to turn sour, risk-averse banks went all out and pushed less risky retail loans — home and auto loans — and were successful in this endeavour.

Farm loan waivers announced by States such as Uttar Pradesh, Punjab, Maharashtra and Karnataka became a cause for concern both for banks and the RBI, as it could undermine credit discipline, increasing the possibility of reduced credit flows to this crucial sector.

Stress likely to reduce

The RBI, in its financial stability report (FSR), cautioned that as per its stress tests, the gross non-performing assets (NPAs) of the banking sector may go up to 10.8 per cent by March 2018 (from 9.6 per cent in March 2017 and 10.2 per cent in September 2017) and further to 11.1 per cent by September 2018. RBI Deputy Governor NS Vishwanathan observed that the overall risks to the banking sector arising from asset quality concerns continue to persist.

Bankers, however, are hopeful that once the 40 large bad loans with exposure aggregating about ₹3.50 lakh crore are tackled under the Insolvency and Bankruptcy Code (IBC) process, and the economy picks up, they could get on with their core business of lending with more vigour in 2018.

They see either resolution or liquidation coming through by April 2018 in the case of the first set of 13 RBI-identified large corporate accounts, which have been proceeded against under IBC. By September 2018, the same would have been happened in the case of the second set of 28 large corporates.

Capital injection and PCA

Moreover, the proposed ₹2.11-lakh crore capital infusion (recapitalisation) into PSBs is expected to galvanise them into action — lend and closely monitor loans for signs of incipient stress.

RBI Governor Urjit Patel has observed that recapitalisation will set up a calibrated approach whereby banks that have addressed their balancesheet issues, and are in a position to use fresh capital injection for immediate credit creation, can be given priority while others shape up to be in a similar position. This is expected to bring market discipline into a public recapitalisation programme.

With almost 10 PSBs being put under the PCA framework, there was intense speculation that many of them would be merged with stronger banks.

The RBI promptly scotched reports of closure of these banks.

Referring to the performance of banks in FY17, the FSR said operating expenses slowed down on account of rationalisation of branches and manpower. The RBI also observed that increasing focus on the business correspondent model has resulted in a steady decline in new brick-and-mortar branches. In FY17, newly opened branches declined by more than 30 per cent. A disconcerting feature, according to the banking regulator, is that 45 per cent of the new branches were opened in tier I centres. A declining proportion of the branches were opened in tier VI centres (population less than 5,000) in recent years.

The Financial Resolution and Deposit Insurance (FRDI) Bill, 2017, became a hot button issue due to concerns that depositors’ money may be on the line if a bank goes belly up in the future. In the wake of these concerns, this Bill, which was approved by the Union Cabinet in June 2017 for introduction in Parliament, was referred to a Joint Parliamentary Committee.

While the RBI and the Centre have rescued (bailed out) distressed commercial banks from collapsing by merging them with other banks in the past, the bail-in clause in the FRDI Bill has stoked fears that depositors will lose their money should their bank go down the chute in the future. The last commercial bank to go into liquidation was Kerala-based Palai Central Bank in the early 1960s. Finance Minister Arun Jaitley has sought to allay such fears.

The year ahead

Bankers hope that once recapitalisation (in the case of PSBs) comes through over the next few months, the aforementioned 40 large bad loans are out of the way, and the economy gathers strength, banks will shrug off risk aversion and proceed full steam ahead on the lending front.

They see credit demand coming in, among others, from the retail and infrastructure segments. On the deposits side, the declining trend in deposit rates could reverse after a couple of quarters as banks may need to mobilise deposits to meet credit demand.