The RBI issues its Financial Stability Report (FSR) every six months for the period ending September and March each year. The FSR for the perioding ending March 2021 was just released on July 01. The RBI Financial Stability Report basically captures the key risks to the macro economy as well as the banking and financial system in India. Broadly, the message of the RBI FSR for March appears to be 4-fold.
- Banking NPAs are a concern and could burgeon in the coming FY22 by about 250 to 400 basis points, depending on a base case scenario or a worst case scenario.
- While the moratorium did cause pressure, it also saved the banks from a spate of retail and MSME defaults. This was a good move in retrospect despite the risks.
- Banks have seen their cost of funds come down drastically but loan yields are also down and so the accretion to the Net Interest Margins or NIMs is just about 20 basis points.
- The capital adequacy of the banks had improved combined with better ROE and ROA. However, the real test would come only when the credit / deposit ratio picked up.
Here is what the RBI FSR actually said about the Indian financial system.
Stiff conflict between inflation and growth
Let us talk about the inflation risk first. The central bank has cautioned that the sharp spike in commodity prices across metals, oil and agri commodities could directly spike food inflation and indirectly spike core inflation. RBI has warned that some of the emerging markets including India could see some of its welfare gains evaporating due to inflation.
The irony was that economy activity continued to be tepid amidst high inflation. The impact of COVID 2.0 had been deeper than expected. The government was caught in a vicious cycle with respect to finances. On the one had to spend on fiscal stimulus and on the other hand it had to contend with lower direct and indirect tax revenues due to weak growth.
Too much deposits, not enough credit, but ready to lend
That was the second big message coming from the RBI FSR. In India, CASA deposits were growing rapidly but loan growth remained tepid. For Mar-21 half year, deposit growth of scheduled commercial banks was 11.9% while loan growth was 5.4%. This is the lowest credit / deposit ratio in recent memory and is a case of too much deposits in the system due to surplus liquidity but not enough demand for bank finance.
But the RBI FSR also underlines that banks are ready and all set to lend. There are several reasons banks are all set to lend. ROE of all SCBs grew sharply from 4% to 7.7% in the last 18 months while the ROA also expanded from 0.4% to 0.7% in the same period. To add to the readiness of the banks to lend, the Capital adequacy ratio has improved by 130 bps to 16% as of Mar-21. Although C/D ratio is low, the bank balance sheets are ready to lend.
NPA story looks bad, but it could have been much worse
RBI has sounded some warning signals on the gross NPA front. Banking NPAs are likely to go up from 7.48% in Mar-21 to 9.80% by Mar-22. Even 9.8% is just a baseline scenario and in a worst-case it could go as high as 11.22%. That is not good news. Industrials dominated with 11.3% NPAs followed by agricultural borrowers at 9.8%. Retail loan NPAs were just about 2%. Needless to say, the NPA impact would be the sharpest on PSU banks but private banks and NBFCs are unlikely to be spared.
But the RBI also has good news in that it could have been much worse without moratoriums. Stress tests indicate that Indian banks are sufficient capitalized to meet NPA eventualities while the provisioning coverage ratio (PCR) of banks increased by 270 bps to 68.9%. More importantly, if the RBI had not given the moratorium, things could have gotten really bad for MSMEs and retail borrowers. What is material is that even after the moratorium, the restructured advances are just about 0.9% of total advances of banks.
In a nutshell, the moral of the story is that once the growth momentum starts at a macro level, the Indian banks are fully poised and ready to unleash their lending prowess. That is the good news coming from the RBI Financial Stability Report.