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In the interest of Indian banks and borrowers

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Shaktikanta Das, the Reserve Bank of India (RBI) Governor, attends a news conference in Mumbai, India, 12 December, 2018 (Photo: Reuters/Danish Siddiqui).

In Brief

India’s economy contracted by 23.9 per cent in the second quarter of 2020 as the COVID-19 pandemic severely hampered economic activity. To support growth, the Reserve Bank of India (RBI) has cut official interest rates by 115 basis points in 2020. A slew of liquidity enhancing measures, including a reduction in the Cash Reserve Ratio (CRR), were announced to nudge banks to lend to productive sectors of the economy.


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Indian banks have been bruised by COVID-19, with the pandemic halting recent improvements in the health of the sector. The RBI’s most recent Financial Stability Report showed that gross non-performing asset (NPA) ratio of commercial banks improved to 8.5 per cent in March 2020, compared to 9.3 per cent in September 2019. The pandemic has reversed this trend: the same RBI report projects that the NPA ratio may increase from 8.5 per cent in March 2020 to 12.5 per cent in March 2021 under a baseline scenario, and to 14.7 per cent under a severely stressed scenario.

The COVID-19 outbreak and subsequent lockdowns have severely affected the economy, impairing the ability of borrowers to repay loans. The RBI has responded with a series of relief measures, including a loan moratorium that provided relief to borrowers whose incomes were impacted by the nationwide lockdown.

The six-month moratorium came to an end on 31 August, with some bankers calling on the RBI not to extend it beyond that date, arguing that it could lead to a surge in NPAs while unduly benefiting borrowers who retain the capacity to repay loans. When the RBI decided not to extend the moratorium, a number of individual borrowers, hotel associations and real estate companies filed a petition before the Supreme Court seeking a waiver on various interest payments.

In a practical sense the moratorium is still in place, as the Supreme Court directed that no account that was not an NPA on 31 August should be declared an NPA until further orders. The RBI, meanwhile, has announced a one-time restructuring of loans to provide relief to retail, SME and corporate borrowers facing COVID-induced stress.

This one-time loan restructuring was a necessary intervention as India’s corporate sector has seen a sharp dip in its earnings because of the lockdown. According to one estimate, around 40 per cent of corporate loans would require restructuring by banks. Another study suggests that banks are likely to restructure up to Rs 8.4 trillion (US$114 billion) in loans, or 7.7 per cent of the total system credit. Firms in the non-financial sector reported a contraction of 37 per cent in sales and 82 per cent in after-tax profits.

Loan restructuring helps borrowers as they can delay repayment of loans, but sectors like aviation, tourism and hospitality have been adversely impacted by the pandemic in a way that loan restructuring cannot substantially help. Their chances of revival are conditional upon improvement in consumers’ discretionary spending. However, the RBI’s Consumer Confidence Survey suggests that consumers are pessimistic about the economic scenario and do not expect to increase their non-essential spending in the coming year.

While the government may put some equity into public sector banks, given its fiscal constraints, one of the biggest risks today is regulatory forbearance. If the regulator allows banks to slip back into the so-called ‘extend and pretend’ mode — whereby loans are not recognised as bad assets and companies are not taken to bankruptcy courts by creditors for fear that there are few buyers or that there will be little loan recovery — this can create moral hazard issues. Even borrowers who might have paid back their loans will not feel the pressure to do so.

The government’s fiscal position is under stress, with the slowdown in economic activity leading to a collapse in revenues even as expenditure remains high. While there is no doubt that the fiscal deficit target fixed for the year at the time of budget presentation needs to be revised, such revision needs to happen in a transparent manner to maintain confidence in the bond market.

Despite these constraints, addressing the banking sector’s issues has to be a part of the strategy to revitalise the economy. The interests of borrowers and banks alike have to be considered. Banks are paying interest on deposits and need interest income on loans to sustain this activity. Borrowers, meanwhile, have been adversely impacted by the COVID-19 lockdown. One solution could be for the government to direct banks to waive interest accrued on loans. Since banks would be asked to forego interest on loans, they would incur costs. When there is a cost incurred by financial service providers like banks in fulfilling such a government mandate, they should be reimbursed by the government.

It is a careful balancing act, but the Indian government must step in to hold the confidence of the economy and banking sectors to weather the pandemic.

Ila Patnaik is Professor at the National Institute of Public Finance and Policy (NIPFP), New Delhi, and a former principal economic advisor to the Government of India.

Radhika Pandey is a fellow at NIPFP.

This article is part of an EAF special feature series on the novel coronavirus crisis and its impact.

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