After August, the road ahead for banks

One of the key issues concerning the responses of central banks to the Covid-19 economic crisis relates to keeping the banking system operationally and financially “resilient” so that they provide critical services to the real economy. The matter of “resilience” has to be seen as distinctly separate from “stability” though both these terms are intrinsically interconnected.

The approach of the Bank for International Settlements (BIS) owned by 62-member central banks and monetary authorities from around the world, which mainly promotes international cooperation among monetary and financial authorities, primarily reflects the international consensus in this area.

In a seminal speech at the BIS’ annual general meeting last month-end, Claudio Borio, the head of its Monetary and Economic Department stated that “using the available flexibility (emphasis added), many authorities temporarily eased both capital and liquidity requirements; imposed blanket distribution restrictions, such as on dividends; and eased the classification of exposures, such as non-performing loans as well as the regulatory treatment of accounting losses — specifically, the new expected credit loss provisioning standards”.

Basel and India

The emphasis, globally, has been on flexibility for the sake of revival of the economy.

A depiction of the proportionality of various measures used by a representative sample of countries is depicted in the graph. In India too, the RBI and the Government have acted in concert to pave the way for sectors like the MSME, agriculture, micro credit and NBFCs to lead the revival.

The task now is to sustain this momentum through continued monetary, fiscal and regulatory interventions.

Among the big challenges would be support for the priority sector as defined by the RBI or the “regulatory retail” as per Basel norms, after the expiry of the moratorium and the standstill on asset-classification at the end of August.

With a contraction in the economy a certainty this year, we believe that cash flows for many borrowers will not support repayment of dues, even after the end of the moratorium.

As a result, if NPAs spike towards the last two quarters of the year, it will strain the capital adequacy of banks which will, in turn, impact credit delivery.

How to balance concerns about capital adequacy with the overarching, immediate need to push for growth will be a difficult question that the RBI will have to contend with, if the fallout of Covid-19 remains more protracted than currently anticipated.

In this context, the RBI Governor has already advised banks to raise capital on a priority basis.

We have been traditionally more conservative than the international consensus on prudential norms and rightly so. Against a baseline capital adequacy of 8 per cent as per the Basel III global regulatory framework we started off with 9 per cent. The buffers (which are above this) might get drawn down in exigencies and the BIS’s official view seems to indicate an acceptance of such a possibility.

Proposed steps

Recognising that “fallacy of composition” may be more valid than ever before and since this is still a crisis in the making, we would suggest the following regulatory steps to cope with the stress on Indian banks’ loan portfolio during the current financial year.

As per Basel norms for risk-weightage, “regulatory retail” exposures are weighted at 75 per cent and the maximum aggregated exposure to one counter-party cannot exceed an absolute threshold of €1 million. The RBI could recalibrate the threshold of “regulatory retail” from the current ₹5 crore (fixed a few years earlier) to ₹8.5 crore.

This could be justified given that the rupee is currently trading 86 against the euro. This change would be perfectly in alignment with the spirit of Para 55 of the Basel III framework and free up a few valuable basis points of capital for the system. Incidentally, the high-powered UK Sinha Committee on MSMEs had also made a recommendation along these lines, further validating our suggestion.

There is definitely a case for treating “default” in retail loans including MSME, home loans, agriculture, micro loans and the like (broadly “regulatory retail”) differently. As outlined in Para 452 of Basel II (which is adopted in Basel III as well) in the case of retail and PSE obligations, for the 90 days figure, “a supervisor may substitute a figure up to 180 days for different products, as it considers appropriate to local condition”.

This flexibility which is already provided by Basel could be judiciously used by the RBI on a sector-wise basis with a clearly defined timeline to return to the 90-day norm after a specified period. It would be much better than being forced to change the current norm because of the continued cash-flow problems expected to continue this year.

For agriculture and particularly Kisan Credit Cards, it is time we got off the current high horse of asset classification norms and accepted the flexibility in the time norms that the Indian Banks Association has been clamouring for.

This relaxation might be done at least for loans to small and marginal farmers. By no stretch can it be said that the changes will tantamount to “evergreening”.

After all, we should remember the nation has thrived on the capacity of the small and marginal farmers to “evergreen” the earth and return harvest after bountiful harvest.

We also end on a positive note. Even though fears are being expressed about the asset quality of banks, we believe that a significant amount of consumer deleveraging is happening in the current fiscal. If such a trend continues, the flip side could be a delayed pick up in consumption thus impacting growth adversely, but on the other side, it will definitely have a positive impact on banks’ asset quality after the moratorium ends at least on the banks’ retail book!

The authors are Group Chief Economic Advisor, SBI and a top bank executive respectively. Views are personal