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Coronavirus impact: Banks to get hit due to rising credit downgrades

But banks are staring at risk of corporate credit downgrades by the rating agencies. The rising ratings downgrades actually threaten to blow up banks' capital buffers

twitter-logoAnand Adhikari | April 30, 2020 | Updated 21:50 IST
Coronavirus impact: Banks to get hit due to rising credit downgrades

The banks are strategising the post-COVID-19 world from multiple fronts such as the possible asset quality deterioration, liquidity management and the capital challenge.

The liquidity challenge is the least of the worry, say bankers, as they would find ways to deploy the funds. The asset quality deterioration is not expected to show up immediately as the RBI provides them regulatory forbearance in NPA classification for a three months. There are expectations of further extension to it and on restructuring of loans.

But banks are staring at risk of corporate credit downgrades by the rating agencies. The rising ratings downgrades actually threaten to blow up banks' capital buffers.

In a recent CRISIL study, the downgrades have actually outnumbered the upgrades in the second half of 2019-20. This isn't surprising as the economy has been on a downswing for the last 12 months. Another rating agency ICRA saw the downgrades in the corporate sector more than doubling during the same period. The corporates have entered the COVID crisis in a bad shape.

The downgrade matters for the RBI as well as banks as risk-weights in capital calculation are decided based on the rating profile of borrowers. Lower the rating, higher the risk-weights.

The risk-weights influence the capital as riskier assets eat away bank's capital. Take, for instance, the RBI has fixed higher risk-weights for unrated corporates, unsecured loans with no collateral and for lower investment grade corporates (B, BB, A).

So how much could be the damage to banks' capital?

The RBI has recently done a study of different stress scenarios based on the geopolitical tension, trade war and the global slowdown. In a severe or most stressed scenario, the RBI has predicted the capital adequacy of banks falling to 12.7 per cent by September 2019 from the current 15 per cent-plus. The projection for gross NPAs was pegged at 15.6 per cent , up from current 9.4 per cent.

This stress test scenario was built in pre-COVID days in December last year. Nobody knows how much economic damage COVID would unleash as the entire world is still fighting the virus and also pumping in trillions of dollars to avoid a long recession. If the above scenario gets replicated, the banks would still be in a better position at 12.7 per cent capital adequacy against the minimum 9 per cent, but they would be without any buffer. The ones with lower capital would certainly find it difficult to do any lending business.

But if the COVID impact breaches the above numbers, there could be serious threat to banks. Meanwhile, many private sector banks are already in capital-raising mode to create additional capital buffers. The government should also recapitalise the banks to put them on a strong footing not only to fight the COVID impact, but also to continue lending in the economy as the growth would be a big casualty.

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