Of the world’s major economies, India’s banking sector warrants the most concern because it entered the pandemic in poor shape and the scale of damage to private balance sheets suggest it will be hit hard by rising defaults, according to consultancy Capital Economics
“[India’s banking] sector is entering a slow-burning crisis, where bad debts will eat into profits and restrict lending, holding back the recovery throughout the decade,” wrote economists Shilan Shah and Simon MacAdam in a report issued on October 29.
Around the world, banks are set to pick up a greater share of the costs of the Covid-19 crisis as governments scale back policy support, but this is not expected to lead to full-blown banking crises in most countries because of ongoing central bank support and relatively low burdens of household debt. The exception is India, according to Capital Economics.
India’s banks are among the most unprofitable in world. Missed payments by debtors, high loss provisions and high costs for managing a ballooning portfolio of impaired assets meant that almost half of India’s banks were loss-making in 2019, according to Refinitiv data.
In comparison with global peers, the weaknesses in India’s larger banks appear even starker. Many Indian lenders came into the crisis with high shares of non-performing loans (NPL) and low regulatory capital ratios by international standards, according to World Bank data.
“It would not take much for loss provisions to push profits into negative territory and begin eating into regulatory capital,” Mr Shah and Mr MacAdam wrote.
Among Indian lenders, Industrial Development Bank of India (IDBI) had a NPL ratio of 27.5%, Yes Bank had an NPL ratio of 16.8%, UCO Bank 16.7%, Indian Overseas Bank 14.7% and Punjab National Bank 14.2% at end March 2020, according to The Banker Database.
The Indian economy has already taken a sizable hit from the crisis and containment measures remain stringent. The government’s fiscal response has been “underwhelming”, the report claims.
The Reserve Bank of India introduced a loan restructuring scheme in August that should help to ease near-term cash flow issues for struggling firms and households. But anecdotal evidence suggests that take up has been low and the scheme only runs until year-end, the economists wrote.
More than 70% of India’s banking sector is state-owned — a higher share than in most major emerging markets — so when bank losses mount, the Indian government is unlikely to remain idle. It has already announced plans to infuse capital into state-run banks in response to Covid-19, but at just 0.1% of GDP, this is a drop in the ocean, according to Capital Economics.
Prime minister Narendra Modi’s administration has previously demonstrated that it will stand behind banks when necessary, notably with the large-scale recapitalisation package in 2017. Moreover, the Reserve Bank of India takeover of Yes Bank in March, prior to the outbreak of the virus in India, suggests that even private lenders deemed systemically important would not be allowed to fail.
India will suffer one of the weakest recoveries among major economies
“All of this would go a long way to the mitigating the risk of a banking sector meltdown in India,” Mr Shah and Mr MacAdam wrote.
Nonetheless, a slow-burning crisis is likely, according to Capital Economics, as India’s banking sector enters a period of ‘Japanification’, characterised by a rise in non-performing assets that eats into profits and restricts lending as banks seek to conserve capital.
Such a scenario would “severely dampen” a rebound in investment as well as squeezing household consumption. “[It] underpins our view that, relative to potential, India will suffer one of the weakest recoveries among major economies over the next few years,” Mr Shah and Mr MacAdam conclude.