The RBI's Financial Stability Report (FSR) released on January 11, 2021 warns of serious financial risks to the economy (described as "unintended consequences") caused by the monetary and fiscal measures pursued to revive the economy.
It says the financial vulnerabilities "incipiently pre-pandemic" have "intensified" and "pose headwinds to a fuller recovery". Its macro stress tests show that the Gross NPA (GNPA) ratio of Scheduled Commercial Banks (SCBs) is likely to rise from 7.5% in September 2020 to 13.5% by September 2021, under the baseline scenario, and 14.8% under the severe stress scenario indicating "possible economic impairment".
What does the worsening GNPA ratio mean?
Macro-financial risks to the economy
The RBI's Report on Trend and Progress of Banking in India, 2019-20, released on December 29, 2020 says in FY20, the GNPA ratio of the SCBs was 8.2% and the total GNPA was Rs 9.15 lakh crore. At this rate, 13.5% to 14.8% GNPA ratios would translate to Rs 15 lakh crore-Rs 16.5 lakh crore of stressed assets in the SCBs.
This would mean further reluctance by banks to provide long-term credit for investment.
In addition to deterioration in the SCBs' asset quality, the RBI report flags two more worrying aspects: (i) capital buffers in the SCBs likely to fall "below the regulatory minimum" and (ii) "the disconnect" between some segments of financial markets (like the booming stock market) and the real economy "has been accentuated" and the stretched valuations of financial assets "pose risks to financial stability".
If the current monetary and fiscal policies are pursued for a longer period, it warns that authorities would "eventually" be locked into "forbearance and liquidity traps".
The RBI Governor Shaktikanta Das' advice (in the foreword): "Banks and financial intermediaries need to be cognisant of these risks and spill-overs in an interconnected financial system."
Inter-connectedness of financial institutions makes it easier for the malaise to spread to the entire financial system, thus posing a macro-financial risk to the economy.
What this report ignores is that India is already in a liquidity trap and that the RBI has played a major role in this. Until October 31, 2020, RBI facilitated Rs 12.7 lakh crore of liquidity through various instruments.
A substantial part of this liquidity gets parked in its own reverse repo account daily as banks prefer the safety and assured interest earning of 3.35% of such deposits, instead of lending to businesses, which have little need for credit in an economy hit by demand depression in any case.
The following graph maps the daily deposits in RBI's reverse repo account from January 1 to November 21, 2020.
Notice how the deposits rose sky-high in response to the RBI's cheap credit after the lockdown. The repo rate (at which the RBI lends to banks) came down from 5.15% until March 26, 2020 to 4% in May 2020 where it stands now.
Spree of writing off loans (NPAs) to private companies
The other negative fallout of persisting with the current monetary and fiscal policy that the RBI flagged off is locking authorities into "forbearance".
Here "forbearance" stands for the moratorium on loan repayment, freezing of classifying bad loans as NPAs and restructuring of loans declared during the lockdown. When these measures are withdrawn, the RBI warns that the GNPA ratio is likely to jump from 7.5% to 13.5% and 14.8% at different stress levels.
The RBI does not explain why huge amounts of loans availed by private businesses are routinely being written off and banks are recapitalised with public money in compensation, thereby incentivising more loan defaults. The RBI has stopped even providing data on NPA write-offs in its database. It zealously guards the identities of big loan defaulters too.
In August 2020, it provided year-wise NPA write-offs from FY04 to FY20 (up to December 31, 2019) in response to an RTI query from a Pune-based businessman, Prafful Sarda. The RBI's banking trend report of 2019-20 mentioned earlier provides the total NPA write-off for the full fiscal year of FY20.
The following graph uses these disclosures to show how loan write-offs by the SCBs and public sector banks (PSBs) dramatically increased during the past six years since the NDA-II came to power. As against Rs 2.2 lakh crore during the 11 years between FY04 and FY14, the loan write-offs went up to Rs 8.7 lakh crore in six years between FY15 and FY20 - 4 times.
Notice, the PSBs account for the bulk of loan write-offs (76.5% of the total) and are compensated for it periodically with public money.
Much has been made of the recovery of written off NPAs.
The graph below maps the NPA write-offs and their recoveries by the SCBs between FY15 and FY20 (up to December 31, 2019) using the RBI's 2020 RTI reply mentioned earlier.
The total recovery is less than 10% of the total NPA write-offs. (The RTI reply did not give any information on recovery before FY15.)
The Insolvency and Bankruptcy Code (IBC) is unlikely to help much in cleaning up bad loans. Former RBI Governor Urjit Patel disclosed in his book "Overdraft: Saving the Indian Saver" that the central government diluted the code and the RBI's powers to undermine efforts to clean up the bad loan mess (NPAs). This led to his eventual resignation from the RBI in December 2018.
In view of all this, the current governor's advice to banks and financial intermediaries "to be cognisant" of macro-financial risks to the economy is uninspiring.
Is further recapitalisation of banks on cards?
The RBI's FSR does not talk about recapitalisation of banks. Between FY15 and FY20, the government has pumped in Rs 3.16 lakh crore of public money for this (compensate banks writing off loans).
But Arvind Panagariya, former Niti Aayog deputy chairman, does seek this. In an article headlined "Four Recommendations for FM", he strongly recommended the finance minister to "recapitalise in advance the public sector banks (PSBs) on a sizable scale" in her forthcoming budget.
His logic: In its first term (2014-2019), the NDA-II government was slow to act on the NPAs front, as a result of which "the economy paid a high price for it" with both credit and GDP growth slipping. He expects a rise in NPAs once the "forbearance" is lifted, hurting growth in credit and GDP, and hence the recommendation.
Given the intellectual heft Panagaiya enjoys with the NDA-II government, his advice can't be dismissed lightly. Although it is not clear how recapitalisation of banks will help credit and GDP growth when (i) excess liquidity with banks is daily parked in the RBI's reverse repo account and (ii) without addressing bad loans/loan defaults that leads to financial stress and lower credit growth, unless the idea is to write off more loans of private businesses.
As for credit growth, the FSR further points out that while bank credit growth (YoY) has declined in FY20 and remains sluggish since then, deposit growth has been robust (in the double digits) "reflecting precautionary saving in the face of high uncertainty".
Does credit growth matter in the current situation?
The RBI's FSR provides evidence of what ails the economy.
It presents a table - reproduced below - listing "major impediments to a robust economic recovery post COVID-19" its systemic risk survey (SRS) revealed.
What the table suggests is the need for high fiscal spending to revive demand and kick-start the investment cycle as well as framing of policies to address issues like supply chain disruptions, workforce reduction/employee stress, lower productivity etc., rather than a need to boost credit growth as Panagariya tells the finance minister.