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New Stress Pockets

New Stress Pockets

Unsecured personal loans, credit cards, business banking, and MSME loans are emerging as new breeding ground for banks NPAs. How serious is the problem?

Illustration by Raj Verma Illustration by Raj Verma

In a large Mumbai-based private bank, collection and recovery targets for executives in the credit cards and personal loans division have doubled this year. The bank is using advanced data analytics and engaging with multiple new-age technology firms in risk management. It is analysing granular data of Covid-hit states for exposure in home or personal loans, nature of employment of borrowers (services or manufacturing), and impact on income post the Covid second wave.

The delinquency management strategy of the bank includes a "collection strategy" for loans under default between 90 and 180 days. The 180 days plus default accounts will straightaway move to recovery using legal remedies or selling to asset reconstruction companies (ARCs). "There is pressure on keeping delinquencies low by proactively reacting to stress cases by selling loans to ARCs or exploring other legal remedies," says a market player aware of the banks collection strategy. The bank knows this time round the government or the Reserve Bank of India (RBI) is not likely to be as sympathetic as it was last year.

In another private bank, the top management was vindicated when the Covid second wave started. The bank was selective in extending additional credit to weaker MSMEs under the emergency credit line guarantee scheme (ECLGS). It set a tough criterion to approve requests for additional working capital loans under the scheme. "We looked at whether the MSME would survive Covid lockdown losses," says the banks senior management executive on condition of anonymity. The bank had given fewer loans compared to competitors. The public sector banks (PSBs), which were quite liberal in accommodating MSMEs, are now staring at local lockdowns which would again hit small businesses. Any delayed economic recovery will pile up losses in a business segment that traditionally has high NPAs.

NPAs in Retail Portfolio

Clearly, banks' pain points relate to unsecured personal loans, credit card outstanding, business banking and MSMEs which are the new breeding grounds for NPAs. It involves loans worth Rs 28-30 lakh crore accounting for 30 per cent of the total bank loan book. The RBI which had in January said that 'India has bent the Covid-19 curve like Beckham' has now got into action. In a video call early this month, multiple CEOs of PSBs explained the worst-case scenario in their loan portfolio to RBI's top brass. Some CEOs sought extension of the one-time restructuring in view of the second wave of Covid. The RBI, however, was non-committal but reminded banks to conserve capital, devise ways to unlock capital and raise more capital where possible.

So, how serious is the problem? Global financial services firm, Macquarie Securities has predicted gross NPAs in the retail portfolio to double to 4 per cent. This assessment was done in December when Covid was on the decline and everyone was forecasting a V-shaped recovery. Macquarie then said the market should not be overly concerned about retail defaults, but the Covid second wave has thrown those forecasts out of the window.

The seven Covid-hit states are now estimated to account for nearly 45 per cent of banking loans. Some banks have started stress testing their loan portfolio for a possible third Covid wave. In a recent interaction with brokerage firm Emkay, Kaushik Mehta, Founder, and CEO, RULoans Distributions, one of the Direct Selling Agents for bank lenders, revealed banks are seeking DSA help to secure collections, which was almost negligible in January-March this year. "This indicates growing desperation in lenders. The risk of customers skipping payments or making part payments, too, is on the rise," opines Mehta. Banks are now more exposed as loan moratorium and one-time restructuring benefits are no longer available to stressed borrowers. The banks have no option but press the recovery button.

In the last five years when corporate credit was sluggish, there was a rush towards high-margin retail segments like personal loans, microloans, consumer durables financing etc. Many experts suggest the whole game shifted to moving down the credit ladder. Some banks started giving loans to sub-prime customers. Currently, credit card portfolio stands at Rs 1.16 lakh crore, while the most risky personal loans have an outstanding of Rs 7.79 lakh crore. Consumer durable loans, a new segment for banks is at Rs 7,242 crore. Within retail, the share of unsecured loans has been rising in the last five years. There is danger now since there is no collateral or sufficient assets to back these loan exposures. In many cases banks have not sought adequate collateral due to competitive reasons.

Anshuman Panwar, Co-founder, Creditas Solutions, which works on the retail side with banks and NBFCs, says there is definitely stress in the retail portfolio. "The average ticket size could be as low as Rs 50,000 and the number of customer accounts would be huge," says Panwar. In 2020/21, the banks' maximum slippages, meaning fresh NPAs, have been coming from retail portfolio. Now, private banks have a higher share price of unsecured retail whereas PSBs have more stressed MSMEs in their portfolios.

"Unsecured retail saw slightly higher than expected slippages. However, this is a small part of the overall book," defended Sumant Kathpalia, MD & CEO, IndusInd Bank, while interacting with investors in January. Around 10 per cent of the banks' retail portfolio is in unsecured retail. Vishwavir Ahuja, MD & CEO, RBL Bank, recently informed that bulk of the slippages, around Rs 1,300 crore out of Rs 1,470 crore, were on account of retail businesses in the third quarter. ICICI Bank recently released the data which had proforma NPAs of Rs 8,280 crore for the third quarter of FY2021. There was an increase of Rs 6,870 crore in proforma NPAs compared to September 2020. A large part of proforma NPAs has come from the retail business.

SBI Credit Card & Payments, for example, has seen gross NPAs at 1.61 per cent, but if one looks at proforma NPAs, the figure shot up to 4.51 per cent in Q3 of FY2021. The banking industry is expecting stressed loans in credit cards to be around 10 per cent. But the banker defends it, saying credit cards by nature are unsecured products where high-interest rates are charged to cover likely losses. The problem could be on personal loans if the economic situation deteriorates. "The sheer intensity and scale of Covid has upset banks' existing credit models. There is a complete discontinuity in data sets both on customer credit behaviour and macro fundamentals," says Alok Tiwari, Co-founder & CEO, Cognext, a risk management advisory Fintech.

Fitch Ratings has recently stated that apart from retail loans, they consider micro, small, and medium enterprises to be most at risk. "There are also asset quality concerns since banks' financial results are yet to fully factor in the first wave's impact and the stringent 2020 lockdown due to forbearances in place," noted the rating agency. Despite being the worst-affected segment, MSMEs had shown a 10 per cent growth in credit last year. MSMEs loans in the system are around Rs 18-20 lakh crore. There are some bankers who suggest that no new money is going from banks to MSME customers. NPAs are already estimated to be at 10 per cent. Under MSMEs, maximum loan growth has been in priority sector and medium enterprises. Clearly, the reason being; one-time restructuring, government guarantees to banks for collateral-free loans and other relaxations. "MSMEs really needed collateral-free loan. RBI data shows higher growth in credit. It was important to restart small businesses," believes Meghna Suryakumar, Co-founder & CEO, Crediwatch, which works with banks. Experts reason the policy of extending and pretend is in full display in the MSME sector. It all started with the RBI and the government directors fight at the board to provide a restructuring to MSMEs, including Mudra loans, where the NPAs were in the region of 20 per cent.

The RBI under then-governor Urjit Patel, resisted the move, soon gave in to board pressure, announcing one-year restructuring for loans up to Rs 25 crore till December 2019. This facility was given to all MSMEs in default but was a standard asset as of 1 January 2019. Post-Covid, the RBI had no option but to extend the scheme for another year. Later, the RBI announced six-month moratorium benefits. This was followed by Rs 3 lakh crore guarantee cover to banks to disburse collateral-free loans to MSMEs. The one-time restructuring scheme was also available to Covid hit MSMEs. The NPA standstill by the Supreme Court also dissuaded the RBI and banks to declare any MSME loans as NPAs. The IBC proceedings against MSMEs were suspended, which has hidden stress in microloan segments. The government has now made insolvency difficult as minimum threshold for invoking bankruptcy is Rs 1 crore from Rs 1 lakh. Last week, the government extended the ECGL scheme to SMA 0 and SMA 1 to over two dozen sectors. They are offering collateral-free loans to even defaulters.

"We expect asset quality deterioration in unsecured and MSME loans. The actual amount of slippages would be a key monitor in the fourth quarter of 2021/21 management commentary," says Ajit Kabi, BFSI Analyst, LKP Securities. Currently, small finance banks and Bandhan Bank have a large portfolio of MSMEs. These new business models would be tested in the current adverse situation.

"The government is trying to do the maximum it can do, but MSMEs with limited scale and lack of demand do not have the ability to sustain. The write-offs are already happening in the industry," says Abizer Diwanji, Partner and National Leader, Financial Services, EY.

Under the microsegment, the business banking loans are also vulnerable. Banks expect gross NPAs to be in the region of 6-12 per cent. The private bank claims that the majority of these MSME loans are secured and backed by high-quality residential or business properties as collateral. But many of these claims would be now tested if the account defaults in the near future. Experts suggest that those banks who have not focused on risk-adjusted returns will be exposed.

"Apart from regulatory forbearances, the stress is less visible in retail because there are indications that individual borrowers have been dipping into their savings. There is a concern on how far savings will hold if the second wave of Covid results in extended local lockdowns," says Saswata Guha, Senior Director, Fitch Ratings. Guha says savings will likely run out at some stage. However, India's relatively low household debt-to-GDP implies there is aversion to holding high debt among individual households.

"The banks have to reboot their credit models and recalibrate credit strategies and credit management. The traditional data sets are no longer relevant as things are changing every two months," says Tiwari of Cognext. This is not easy as it would take 3-6 months because of the legacy systems. Unlike direct monetary benefits to small businesses globally, India has taken the approach of indirect benefits by way of forbearance wherethe burden fell on banks. While private banks were very cautious, the PSBs doled out the money because of pressure from the government.

"MSME is one area where some out of box thinking is required especially policy intervention. The government should deal with MSMEs structurally. For instance, MSMEs need funds based on cash flow whereas banks lent them based on their annual report or provide funds based on assets or collateral," says Tiwari of Cognext.

The new stress segments will add to the current NPA pile. Banks entered the Covid crisis with 8 per cent NPAs. As per ICRA's estimates, on a proforma basis, gross NPAs of banks stood at Rs 8.7 lakh crore or 8.3 per cent of advances against reported NPAs of Rs 7.4 lakh crore, which is 7.1 per cent for the December quarter. With NPA standstill gone, gross NPAs will now jump by Rs 1.3 lakh crore, equivalent to 1.2 per cent. S&P Global Ratings believes systemic risk facing banks in India is likely to remain high in the wake of the second wave of Covid. The global rating agency estimated the Indian banking system's weak loans at 11 to 12 per cent of total advances. "Indian banks' reported NPAs are likely to surge in the last quarter of fiscal 2021," said S&P. Currently, the loan portfolio stress testing is not as comprehensive and granular as the US. There is need to stress every single loan asset in the balance sheet right from credit card, personal loan to home loans.

"We expect actual stress to be recognised by Q4 of FY2021 and the management commentary will be keenly watched," says Kabi of LKP Securities. Some banks are more vulnerable. Bandhan Bank's gross NPAs, for example, are likely to shoot up from 1.2 per cent in December 2020 to over 7 per cent. RBL Bank will see NPAs rising 1.8 per cent to 4.6 per cent. IDBI Bank, which is just out of the weak bank tag, says collection efficiency has almost reached pre-Covid levels. "We have just 2.5 per cent of our loan portfolio as restructured under the one-time restructuring. It shows units are able to repay their dues," says Rakesh Sharma, MD & CEO, IDBI Bank. The banker faces another challenge of the denominator effect as low credit growth will push up NPAs. Banks are comfortable taking exposure in high- rated corporates where opportunities are fewer and there is a cautious approach in retail and MSMEs. These changes in business model of secured and low margin home loans and high-rated corporate will also impact bank margins.

Banks' Exposure to NBFCs

Banks are exposed to NBFCs, which are into consumer credit to non-salaried classes and risky segments.

NBFCs are dependent on institutional borrowings. "Post-IL&FS, banks have started to occupy a significant share in NBFCs total funding. Direct or actual balance sheet funding is around 45 per cent. However, if one adds the investment portfolio (incl. PCG), the number swells to 55 per cent by our estimate. This exposes banks to NBFC risk which predominantly deal in less affluent, self-employed, and microborrowers," says Saswata.

Currently, of the total loans of Rs 26.42 lakh crore by NBFCs, 18-20 per cent of loans of Rs 5 lakh crore are unsecured. Bank borrowings to NBFCs are also unsecured. Currently, almost 26 per cent of banks' borrowings to NBFCs is unsecured in the last year. The RBI has actually increased limits for banks to put higher money into NBFCs because of the recent liquidity crisis. The asset under management of consumer-focused NBFCs is around Rs 10 lakh crore.

There are hundreds of Fintechs that have doled out credit to sub-prime customers or people with no past history of credit. "Credit is a very cyclical subject. There are Fintechs that have seen only an upcycle. They are now facing a downturn in the economy. In fact, this keeps happening after every 5 -6 years. The focus should be on risk management," says Tiwari.

What if they default? Pat comes the reply. "Thats a wrong attitude. Why will they default?" he said. Risk management is always about bad news and not good news.

According to RBI's financial stability report, the gross NPAs of NBFCs increased from 5.3 per cent of total advances as of March 2019 to 6.3 per cent in March 2020. Under RBI's stress testing, NPA projection is between 6.8 per cent and 8.4 per cent.

Barring home and gold loans, stress in NBFCs comes from MSMEs and unsecured loans, especially small ticket personal loans. According to a recent CRISIL report, the challenge this year will be unsecured personal loans, where underlying stress has increased significantly with early-bucket delinquencies more than doubling for many NBFCs. This segment had last seen such pressure in 2008-10, after the global financial crisis. CRISIL has estimated that NBFC stressed assets may hit Rs 1.5-1.8 lakh crore by fiscal end. (See NBFC Stress Test)

Fitch Ratings has stated NBFCs face renewed asset quality and liquidity risks amid the second wave of coronavirus infections. Commercial vehicle operators, microfinance, and other wholesale borrowers remain at greater risk of stress in this environment. NBFCs are already knocking on the doors of RBI for an extension of a one-time loan restructuring scheme for MSMEs till March 2020.

Challenges Ahead

"I can smell the credit risk," remarked the chief risk officer of a PSB, when a technology company approached the bank for using high-tech advanced risk models for stress testing loan portfolios. There is need for a mindset change towards likely risks in credit. "Credit today is a fairly evolved science," says the technology player who made the presentation. In fact, the proactive approach to risk shows why HDFC Bank has the lowest NPAs across all cycles and there are habitual banks that get caught on the wrong side.

Today, banks need further granularity in card business from regions to the customer profile. Take for instance, how much is the loan exposure in different loan segments in the seven worst-affected Covid states."The database storage costs and processing costs have reduced considerably. Post-Covid, many banks are talking of using advanced data analytics which is more granular. They have to do in the near future to mitigate such risk in future.

As the Covid second wave is unfolding, the only option is to make higher provisioning especially in stressed accounts like MSME loans. The current provisioning requirement is very low. The RBI has set a 5 per cent minimum provisioning for restructured SME accounts. Similarly, the limit for retail and corporate restructured accounts has been kept at 10 per cent. "There is no data to show higher NPAs. Banks should take a tested approach. If the data comes out, there may be a case, but we should wait for some data to come out," believes Crediwatch's Suryakumar.

"Banks having excess provision (ICICI, Axis, Ujjivan) may write-back some provisions, while banks having inadequate provision (majorly PSUs) will have to make additional provision," says Kabi of LKP Securities. "We have followed conservative provisioning approach and added Rs 1,10 crore to Covid provisions taking the total Rs 3,261 crore. We have improved our provision coverage ratio from 77 per cent to 87 per cent on reported gross NPAs and maintained PCR at 77 per cent even after including proforma NPAs. We have taken 100 per cent provisions on unsecured assets, including microfinance, even though we maintain focus on recovery," informed Kathpalia.

If the situation deteriorates, banks and NBFCs have to provide higher amounts from profits, which would also impact capital. Secondly, the low capital base of PSBs is also a concern.

"We believe the PSBs are in a more difficult situation. They do not have adequate core capitalisation while contingency reserves are also low compared to private banks," says Saswata.

The actual NPAs of PSBs are not in absolute numbers and in percentages because they have been indulging in massive write-offs. "That is why banks are reporting low NPAs. Despite low credit growth, the denominator effect is not playing out in showing higher NPAs," says a market expert. The banks are already readying invoking legal action or invoking SARFAESI.

In order to reduce the NPA burden both in terms of provisioning and collection and recovery, private banks are selling unsecured retail loan portfolios, which include personal loans and credit cards to ARCs. In an unsecured loan, banks have to provide 100 per cent provision within one year. "Banks are mostly selling unsecured loan portfolios. These are fresh NPAs and not old or writtenoff accounts," says R.K. Bansal, MD & CEO, Edelweiss ARC. The cash deals with ARCs involve 50-55 per cent upfront payments while SR deals take place at 70-80 per cent of the book value of the loan.

Many banks came up with portfolio sales regarding LAP (loan against property) last year. These are loans taken by smaller firms or proprietorship firms for their businesses. The second category was unsecured loans. NBFCs were the highest sellers last year. We expect NBFCs to remain higher sellers," says Mukund Kulkarni, Head of Retail & SME, ARCIL. But there are capital limitations and pricing on part of ARCs to buy retail and MSMEs loans from banks and NBFCs.

Last but not the least, managing retail NPAs microloans and MSMEs is a challenging task because of large volumes.

Veena Sivaramakrishnan, Partner, Shardul Amarchand Mangaldas & Co, expects a spurt of cases in IBC as the one-time restructuring date has ended and the IBC suspension has been lifted.

Clearly, banks are working on a war-footing to restrict any fresh lending to these segments, further tightening credit standards and focussing on collection and recovery. Many banks have started tightening credit standards for MSMEs. They are working on rebooting credit models. They realised that they need to increase their analytics infrastructure. But this would be a long-drawn process as it generally takes a year to resolve issues with promoters. In fact, the current concerns regarding stress in MSME have already slowed down credit to this segment a bit.