RBI’s stress test shows banks are on thin ice as virus may affect capital

Indian lenders had brought down dodgy loans from 11.6% in FY18 to just 8.5% of their book in FY20. It seems that was just a number on the sand, and all it took was a wave of the pandemic to wipe off this minor victory.

What’s more, the capital that public sector banks wheedled out of the government and their private counterparts boasted about is now looking very vulnerable. Banks will see 12.5% of their loans turning bad this year, for sure.

Their worst nightmare is this ratio climbing up to 14.7% under extreme duress due to the pandemic.

That is the number thrown by the Reserve Bank of India’s (RBI’s) stress tests. In the financial stability report, the central bank paints a gloomy picture on the capital levels of banks and reiterates how important it is to raise money.

Sure, India’s private sector lenders have announced big fund-raising plans with some having already mopped up money from the markets.

The Union government has merged public sector banks in the hope that stronger balance sheets will support the weaker ones.

But the fact remains that the outlook on asset quality and health of capital is still clouded and even the RBI is not offering any clarity on this.

“Given the fact that impact of moratorium is still uncertain and evolving, the exact nature of how the same will play out on the quality of banking assets is difficult to ascertain accurately,” the RBI report said. But, for what it’s worth, the stress tests do give an inkling of the trouble that is ahead.

As a base case, banks will see their capital adequacy ratio drop to 13.3% by March 2021, and the most pessimistic outcome would be a drop to 11.8%. Three banks will see their capital levels dip below the regulatory minimum and, in case of extreme stress, the number of banks will go up to five.

Not surprisingly, the weakest link are public sector banks. The pandemic will result in bad loan ratios surging to 15.1% and a bigger deterioration in capital ratios. To be sure, the stress tests have not taken into account mergers and recapitalization by the government.

Even as stress tests throw out ugly numbers, the central bank’s report said that the moratorium suppresses the real amount of stress on the loan books of banks, and half of the banking system’s loan book was under moratorium as in April.

To be sure, the moratorium levels of banks have come down since then.

The central bank has said that the country’s financial system remains sound. But governor Shaktikanta Das has given sound advice in his foreword for the report. “We need to remain extremely watchful and focused.”

RBI’s stress test shows banks are on thin ice as virus may affect capital via @MasterMindUpdate
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