Asset quality issues are likely to resurface for banks amid credit squeeze in a slowing economy, according to ICRA’s report on the impact of Covid-19 on the banking sector. The credit rating agency expects serious impact on the cashflows of individual as well as corporate entities. Slow credit growth will add to profitability pressures for banks amid likely increase in credit provisions as asset quality stress is likely to go up.

With some large companies involved in production of discretionary items announcing shutdown, the SME (small and medium enterprise) sector, as well as unorganised sector, are likely to be adversely impacted, said the credit rating agency.

In addition to a severe demand slowdown, the report cautioned that many sectors could witness disruptions in payments and an elongation of the receivables cycle, along with the emergence of contractual disputes, all of which would strain the liquidity situation and lead to a rise in delays in servicing debt obligations unless forbearance is extended.

“Moreover, job losses, especially of contractual employees in manufacturing as well as retail sectors, may rise.

“Additionally, the loss of income may result in constrained consumption, some rise in defaults on personal loans, and could emerge as a risk for microfinance institutions, especially in the urban areas,”said Karthik Srinivasan, Group Head, Financial Sector Ratings, and Anil Gupta, Sector Head, Financial Sector Rating.

While emphasising that credit growth will remain slow (likely to remain below 6 per cent in FY21) amid muted economic activity, the report said collections could get impacted across the board and borrower’s leverage is likely to go up with additional working capital requirements and profitability pressures.

Credit supply issues

Repayment moratorium, if provided by the Reserve Bank of India (RBI), could assuage reported asset quality indicators even as inherent stress will build up, the report said. ICRA assessed that bank repayment schedule can get extended, however, debt capital market instruments are unlikely to be rescheduled. Interest rate cuts may be forthcoming, but credit supply issues need to be addressed.

The agency said temporary increase in working capital limits and shift of corporates from debt capital markets to banks is likely to increase the credit demand from banking channel

But the ad-hoc credit limits are likely to increase the indebtedness of the borrowers amid stress on their earnings and cash flows, it added. The agency suggested that banks need to suitably structure such credit limits to ease the repayment burden on borrowers.

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