A state-run Allahabad Bank branch in New Delhi. Photo: AFP

For India’s banks, tackling bad loans will be a major challenge in the coming year as companies continue to grapple with Covid-19 headwinds. The Indian economy had contracted for two consecutive quarters – -23.9% in Q1 and -7.5% in Q2.

On the other hand, private investment continues to remain muted and this will affect corporate loan growth in the coming months. This low demand is despite the availability of ample liquidity in the system.

In fact, for the past few years, private investment has been low, while public spending has been doing the heavy lifting for the economy.

The outbreak of the Covid-19 pandemic early this year has added to the rising non-performing assets or bad loans for the banking industry. Under the guidance of the Reserve Bank of India, banks imposed a six-month moratorium on loan repayments in order to provide relief to millions of borrowers who faced losses of income due to the countrywide lockdown, which came into effect from March 25 and lasted for two months.

The recognition of bad loans was also put in abeyance during the period and subsequently the Supreme Court put a stop on fresh non-performing assets recognition till further orders.

In August, the central bank had also permitted a one-time restructuring of both corporate and retail loans without getting classified as a non-performing asset and had laid down certain parameters to avail such a benefit. Companies under stress have been given until December to make use of the scheme.

In addition, under the Emergency Credit Line Guarantee Scheme, banks have sanctioned loans worth 2.05 trillion rupees (US$27.8 billion) to more than eight million small and medium enterprises that were impacted by Covid-19 disruptions.

The Reserve Bank said in its report that in a “very severe stressed scenario,” gross non-performing assets could rise to as high as 14.7% of total loans by March 2021, and under the baseline scenario, it could rise to 12.5%.

S&P Global Ratings forecast that the banks’ bad loans may rise to 11% of gross loans in the next 12-18 months, from 8% on June 30 this year.

However, the 7.5% contraction in the second quarter had beaten street estimates, including that of the Reserve Bank (9.5%), and this has evoked hopes of a faster than anticipated recovery. Another cause for optimism is the rise in disbursal of agriculture and retail loans from September onward.

Most of the banks, including private-sector lenders, have posted good profits during the July-September quarter. This was mainly on account of treasury income and a reduction in non-performing assets.

But S&P said this improved performance was due to the six-month loan moratorium, as well as a Supreme Court ruling barring banks from classifying any borrower as non-performing assets. It underlined that the bad loan estimates were lower than earlier, but the sector’s financial strength will not materially recover until fiscal 2023.