PSBs may need up to Rs 3.4 lakh crore in two years: Moody’s

Public sector banks (PSBs) may need up to Rs 3.4 lakh crore in external capital over the next two years in a scenario of extreme stress, where asset quality in the corporate segment deteriorates in addition to that in the retail and small enterprises segments, rating agency Moody’s said on Friday.

Despite the forbearance measures, under scenario 1, Moody’s expects newly-formed NPLs to nearly double to about 3.7% of gross loans annually in the next two years from 1.7% in fiscal 2020, driven by the the retail, SME and agriculture segments. “Consequently, banks’ average NPL ratio will increase to about 14.5% by the end of March 2022 from 11% at the end of March 2020, although we expect formation of non-performing corporate loans under this scenario will stay at its historical average,” Moody’s said. It did add, though, that some non-bank financial companies (NBFCs) may also default on bank loans amid continued liquidity constraints and a deterioration of their own asset quality.

In the base case scenario of only retail and micro, small and medium enterprises (MSME) loans turning bad — which Moody’s calls scenario 1 — PSBs will need up to Rs 2 lakh crore. “PSBs are facing large capital shortfalls fresh on the heels of a capital infusion totaling Rs 2.7 lakh crore the government made during fiscal 2017-20 to restore their solvency that had been damaged by large increases in NPLs (non-performing loans) in prior years,” Moody’s said in a report, adding that it expects much of the requisite capital support to come from the government.

Under scenario 1, PSBs will need about half of the required external capital, or Rs 1 lakh crore, to build up loan-loss provisions to about 70% of NPLs, which will leave them with enough capacity to grow loans 8-10% annually, faster than 4% in fiscal 2020, and support economic expansion. With a capital infusion of this magnitude, banks would also be able to maintain capitalisation at levels comparable to those of similarly rated peers globally, with common equity tier-I (CET-I) ratios of at least 10%. Under scenario 2, PSBs’ external capital needs will nearly double to about `3.4 lakh crore in order for them to have CET1 ratios of 10% or higher and loan loss coverage of 70%. Moody’s expects a sharp contraction in the Indian economy to substantially accelerate the formation of new NPLs, driven by the retail and MSME segments.

Although the one-time loan restructuring allowed by the Reserve Bank of India (RBI) will prevent a sudden increase in bad loans, NPLs and credit costs will increase over the next two years, hurting PSBs’ already weak profitability and depleting their capitalisation, the agency said.

Despite the forbearance measures, under scenario 1, Moody’s expects newly formed NPLs to nearly double to about 3.7% of gross loans annually in the next two years from 1.7% in fiscal 2020, driven by the retail, SME and agriculture segments. “Consequently, banks’ average NPL ratio will increase to about 14.5% by the end of March 2022 from 11% at the end of March 2020, although we expect formation of non-performing corporate loans under this scenario will stay at its historical average,” Moody’s said. It did add, though, that some non-bank financial companies (NBFCs) may also default on bank loans amid continued liquidity constraints and a deterioration of their own asset quality.

In the event that scenario 2 materialises, the asset quality forecast for PSBs would be even bleaker, with the NPL ratio climbing to 18% by the end of March 2022 from 11% at the end of March 2020. The new NPL formation could then increase to about 5.7% of gross loans annually over the next two years, exceeding a peak of 5.4% reached in fiscal 2018, according to Moody’s.

The rating firm expects the recast scheme to have limited success, given the historical experience of such exercises. “…a substantial share of restructured loans can become NPLs. We expect that more than 50% of loans banks restructured in 2012-15 slipped into the NPL category,” it said in the report.