The country’s financial sector is going through troubled times. The woes of banks and non-banking financial companies (NBFCs) do not seem to end. Though supportive measures to provide relief to the financial system have been announced time and again, they are unlikely to solve all the issues. The Covid-19 pandemic has further dampened the prospects for infrastructure financing. While the economy recovered from a dismal first-quarter contraction of 24 per cent to a 7.5 per cent contraction in the second quarter of 2020-21, lending from the mainstay financier of infrastructure projects will continue to be cautious. The economic fallout of the pandemic will have a lingering effect on the financial system in the coming fiscal year as well, but things are likely to go northward with the macroeconomic environment improving.
Banks remain cautious
Credit flow to infrastructure projects exhibited a negative growth rate of 0.2 per cent in 2019-20 as against 19 per cent growth in 2018-19, thus reflecting the heightened risk aversion of banks amidst sluggish macroeconomic conditions. The corporate sector’s demand for credit has been slowing since March 2019. This, coupled with modest retail credit growth, decelerated the banking industry’s overall credit growth. Bank credit to infrastructure outstanding as of September 2020 is around Rs 10.15 trillion, marginally higher than that outstanding as of September 2019 (Rs 10 trillion). The extension of moratoriums, provision of credit for relief measures, etc. to battle with the Covid-19 pandemic have left banks with limited headroom for fresh lending to infrastructure.
The year 2018-19 was an outlier when bank lending to the infrastructure sector revived. Credit growth for infrastructure was the highest in at least seven years in both absolute and percentage terms. Power, roads, telecom and other sectors witnessed double-digit growth in bank lending. Visible growth in the affordable housing, telecommunications and renewable energy segments drove credit demand.
The Covid-19 pandemic has decelerated bank credit to infrastructure projects amidst fear of delinquencies. Only a handful of projects have been able to tie up funds since the pandemic hit the country. Financial closures for hybrid annuity model (HAM)-based road projects have become difficult in the falling interest rate regime. Moreover, the slow transmission of policy rate cuts to bank lending rates has squeezed cash flow margins of developers.
As per the Reserve Bank of India’s (RBI) latest financial stability report, the gross non-performing asset (GNPA) ratio of the banking sector may increase from 8.5 per cent in March 2020 to 12.5 per cent by March 2021 in the baseline scenario. If the macroeconomic environment worsens further, the ratio may escalate to 14.7 per cent under the very severely stressed scenario. The stressed advanced ratio in the infrastructure sector has been declining since March 2018, a positive indicator. The ratio, which stood at a high of 22.6 per cent in March 2018, gradually slid to 20.1 per cent in September 2018 and further to 17.8 per cent in March 2019. The GNPA ratio of the infrastructure sector was 13 per cent as of March 2020. Meanwhile, of the total credit to industry, the share of credit to infrastructure increased from 33 per cent as of March 2018 to 36 per cent as of March 2020. These numbers highlight the fact that lending by banks has been more responsible unlike the irrational exuberance exhibited by them in the past.
In the absence of a recapitalisation plan, banks are expected to witness capital erosion and asset quality challenges. The government’s stimulus packages put the maximum onus of lending on banks. Various industry experts believe that banks are expected to see a surge in profits during the ongoing fiscal year due to lower provisioning for stressed assets. However, much of the improved performance is due to the six-month loan moratorium, as well as the Supreme Court’s interim stay on classifying any loan account as a non-performing asset by banks. While a one-year blanket ban on registering fresh insolvencies is a boon for borrowers, any delay in resolutions will potentially put the banks at greater risk of future losses.
Challenging operating environment for NBFCs
Stress in the NBFC segment seems to be unabated since the Infrastructure Leasing & Financial Services Limited default in September 2018. The sector is facing serious liquidity challenges and mounting bad loans. While it was expected that the situation would normalise in the early part of 2020, the onslaught of Covid-19 shifted the focus to asset quality and funding challenges. RBI’s liquidity measures for the NBFC segment, including a Rs 750 billion support for NBFCs and a Rs 900 billion support for power distribution companies, will fall short of solving the liquidity needs of the segment. These have so far benefited larger and better-rated NBFCs, while smaller NBFCs continue to face a credit crunch. The government had also announced the setting up of a special purpose vehicle that will subscribe to new and existing bonds issued by NBFCs up to a maximum of Rs 300 billion. This is the first instance of direct support to the NBFC segment from the government, but the size of the support is far lower than the immediate liquidity requirements of those companies.
According to CRISIL estimates, stressed assets – gross bad loans and potential stress in loan books – as of September 2020 for the overall NBFC segment stood at Rs 1.6 trillion-Rs 1.8 trillion or 6.5-7.5 per cent of the industry assets. Besides, considering the macroeconomic challenges before the country, toxic assets are expected to increase across almost all segments once authorities withdraw the support that has been extended due to the pandemic. Assets under moratorium are dominated by wholesale customers and real estate developers. With the end of the six-month loan moratorium, loan collections for NBFCs improved; however, it is too early to gauge whether NBFCs have successfully withstood the economic shock of the pandemic.
On the liability side, the funding woes of NBFCs are expected to taper gradually. The dependence of NBFCs on banks for incremental lending continues to be high. With a declining share of long-term market debt for NBFCs, the gap is being filled by banks. The overall composition of NBFCs in banks’ credit exposure increased from 6.9 per cent in September 2018 to 8.8 per cent in June 2020, as per a report by Care Ratings. However, lower-rated and small NBFCs have been shunned by banks and markets, as reflected in the lacklustre response to RBI’s targeted long-term repo operations. Loan securitisation, another key fundraising source for NBFCs, is improving, albeit slowly. Investors prefer to buy securitised loan pools with low delinquency rates (such as auto loans and home loans) rather than risky loan pools (such as small business loans and wholesale loans).
Outlook
The K.V. Kamath committee recently came up with recommendations on loan restructuring suggesting that lenders should consider at least five financial parameters before taking a decision on restructuring. It identified 26 sectors for relief and also suggested sector-specific thresholds. Analysts believe that while the financial parameters suggested by the panel are reasonable, some borrowers may not be able to meet the granular requirements prescribed by the committee, resulting in a spike in bad loans. While the recommendation will bring transparency in the restructuring process, there is risk of slippages as well for banks. The overhang of bad loans and the expected spike in stressed assets are likely to keep bank credit growth muted in the near term. Therefore, RBI has urged corporates to tap alternative avenues for financing infrastructure projects. To this end, the government and regulators are taking steps to deepen the bond market, encourage asset monetisation, set up a development finance institution, and attract private and institutional investments in infrastructure.