RBI financial stability report: Bank asset quality to deteriorate in FY21

The financial stability report (FSR) released by Reserve Bank of India (RBI) for July 2020 states that the banking sector is likely to witness a significant rise in the bad loans amid pressure led by the pandemic and the nationwide lockdown.

RBI’s stress test suggests that the gross non-performing assets (GNPA) ratio of all scheduled commercial banks is likely to increase from 8.5 per cent in March 2020 to 12.5 per cent by March 2021 in the ‘baseline scenario’. However, if the macroeconomic environment worsens further, the ratio may escalate to 14.7 per cent in the ‘very severely stressed scenario’.

Further, in the case of public sector banks, the GNPA ratio of 11.3 per cent as of March 2020 might elevate to 15.2 per cent by March 2021 in the baseline scenario. Besides, in the case of private sector banks and foreign banks, the GNPA ratio may surge from 4.2 per cent and 2.3 per cent in March 2020 to 7.3 per cent and 3.9 per cent, respectively in March 2021.

Going with the RBI projections of the GNPA ratio, it is higher than 12.7 per cent reported in March 2000.

The results of the stress test at bank-level indicate that 23 banks with a share of 64.5 per cent in scheduled commercial banks’ total assets might fail to maintain the required capital-to-risk weighted assets ratio (CRAR) in the three standard deviations (SD) shock to the GNPA ratio scenario. One of those 23 banks already had its CRAR below RBI’s required level of 9 per cent even before applying the stress test. In such an extreme shock scenario, the CRAR of all the 18 public sector banks is likely to go down to 9 per cent.

Under the scenario of 3 SD shock to the GNPA ratio, CRAR would fall below 7 per cent for as many as 20 banks, which would dominate the list of banks witnessing large capital erosion. Further, 15 and 20 banks would record over 6 per cent decline in CRAR under 2 SD and 3 SD shocks, respectively.

The above graph shows the assumptions, based on which, RBI’s stress test works. The above assessment is done under stringent hypothetical adverse economic conditions and hence, should not be interpreted as forecasts.

However, if the economic situation worsens further then, the asset quality of the banking sector would indeed come under pressure. Further, RBI says that the actions undertaken by financial sector regulators and the government to mitigate the impact of COVID-19 has eased the operational constraints and helped in maintaining market integrity and resilience in the face of severe risk aversion. Now, it would be interesting to see how the asset quality of banks pans out post moratorium period.