Banking sector: credit risk seems to be under control
In its most recent financial stability report released in late December 2021, the Reserve Bank of India (RBI) confirmed that the banking sector continued to consolidate between March and September 2021. Although this analysis is still biased by government measures to support the most fragile households and enterprises, which were introduced in March 2020 and will run through March 2022, the banking sector should be in a position to face up to the expected increase in credit risk once economic agents no longer benefit from state-backed loans.
On the whole, asset quality, solvency and profitability of the banking sector (including the most fragile state-owned banks) have improved since 2018, and the Covid-19 crisis has not hampered the sector’s consolidation.
The non-performing loan ratio for the banking sector as a whole declined to 6.9% in September 2021 from 8.5% in March 2020. Moreover, although asset quality of state-owned banks is much more fragile compared to private banks, it has been improving. Their average non-performing loan ratio declined from 11.3% in March 2020 to 8.8% in September 2021.
In the construction sector, loan quality is still mediocre, although it has improved slightly since March 2020. According to the central bank, 20% of loans to this sector are still considered non-performing. In industry and services, in contrast, the situation has consolidated, and in agriculture, it is still relatively stable. The quality of household loans has deteriorated: the non-performing loan ratio increased by 0.4 pp to 2.5% between March and September 2021. The most risky household loans are for automobiles and real estate. The impact on the banking sector as a whole, however, is still mild, because household loans account for only 10.5% of all bank loans outstanding.
According to the central bank’s forecast, loan quality is expected to deteriorate between March and September 2022. The non-performing loan ratio could rise by 1.2 percentage points to 8.1% (+1.7 pp for state-owned banks). Meanwhile, non-performing loan provisions are still insufficient. In September 2021, the provision coverage ratio for risky assets was only 68.1% for the banking sector as a whole, and 66.5% for the state-owned banks.
Capital adequacy ratios improved between March and September 2021 thanks to the government’s capital injections into the most fragile state-owned banks and capital increases by the private banks as well as by the more solid state-owned banks. For the banking sector as a whole, the Capital Adequacy Ratio (CAR) rose to 16.6% in September 2021 (vs. 16.3% in March 2021). Moreover, although the RBI expects the CAR to fall slightly to 15.4% by September 2022, all banks should be in a position to comply with the regulatory requirement of 9%, even in the event of an especially severe shock (last year they were not prepared to do so).
Lastly, bank profitability seems to have improved significantly, albeit from very low levels. In September 2021, banks reported a Return on Assets (ROA) and Return on Equity (ROE) of 0.8% and 9.2%, respectively. State-owned banks that failed to generate a profit in March 2020 were able to report an ROA and ROE of 0.5% and 7.7%, respectively, in September 2021.
Bank lending has rebounded since July. Loan growth has returned to levels not seen since mid-2019, even though it is still extremely low (+3.5% on average over the past three months for industrial loans). The recent rebound has been especially strong for loans to small and very small enterprises.
Non-banking financial companies: wide disparities
Non-banking financial companies (NBFC) are still in a fragile financial situation. On the whole, their situation has improved slightly since March 2020, although there are still wide disparities between NBFCs.
According to the RBI, NBFCs produced loans equivalent to 12.6% of GDP in September 2021 (vs. 76.3% of GDP for bank loans). The quality of NBFC banking assets deteriorated slightly between March and September 2021, even though it is more solid than in March 2020. In September 2021, the non-performing loan ratio was 6.5% of total loans outstanding (+0.1 pp relative to March 2021). The non-performing loan ratio was 11.5% for farm loans, 11% for loans to services, and 7.9% for industry loans (40% of loans produced by NBFCs).
On the whole, their capital adequacy ratios are still comfortable. They averaged 26.3% in September 2021 (vs. 23.7% in March 2020). But of the 191 NBFCs analysed by the RBI, 10 NBFCs (whose assets accounted for 4.6% of total NBFC assets) did not comply with the regulatory requirement of 15% (in March 2021, only 7 NBFCs did not reach the regulatory target).
Agricultural reform is abandoned
In fall 2020, Narendra Modi’s government adopted several major reforms to stimulate medium-term growth. Among them was an agricultural reform programme. This reform aimed to increase productivity in a sector that employs a big share of the active population. Last November, however, faced with fierce opposition from farmers, the government finally decided to withdraw the reform. Abandoning the reform could enable Modi’s party to win more seats in the regional elections to be held in Uttar Pradesh in the first part of 2022. Yet it raises doubts about the government’s capacity to carry out vital reforms.
