This article was written by Suvashree Ghosh and Jeanette Rodrigues. It appeared first on the Bloomberg Terminal. 

India has rolled out a fresh plan to tackle an old problem: the mountain of bad loans held by its banks. With the pandemic forecast to push soured assets to a two-decade high, Prime Minister Narendra Modi is struggling to find cash to support the state-run lenders that hold most of it, and to spur credit to a shrinking economy. Most of the risky debt is concentrated in two sectors — telecoms and utilities — that are vulnerable to the economic slowdown, meaning if they face more trouble, then a massive amount of debt goes bad.

1. What’s the plan?

When the pandemic slammed India early this year, the central bank allowed lenders to freeze loan repayments through Aug. 31. Jefferies estimates that borrowers accounting for 31% of outstanding loans took up the offer initially, though this eased to about 18% by the end of June as businesses gradually reopened and some realized that postponing repayments could end up being costlier. The focus then shifted to a one-time debt restructuring allowed by the Reserve Bank of India for borrowers that were on track to repay before the lockdown. Lenders can grant loan extensions of as long as two years with or without a freeze on repayments. They have until the end of the year to pick which loans to overhaul and until June 2021 to get it done, and will also need to set aside higher provisioning.

2. Why now?

India’s $1.8 trillion financial system entered the pandemic already weakened by about $140 billion of bad loans at its banks and a 2-year-long liquidity crisis at so-called shadow banks. Then business activity collapsed after Modi’s government instituted some of the world’s strictest shelter-at-home rules in March. The economy is forecast to shrink this year for the first time in more than four decades. The Reserve Bank’s stress tests show the bad-loan ratio will rise to 12.5% by March 2021 — the highest since 2000 — from 8.5% last March (the end of India’s financial year). Private analysts warn that it could go even higher. India Ratings estimates about 8% of total bank credit may have to be restructured and the fate of the rest will depend on whether authorities can control the pandemic fast enough to restore economic growth.

3. Which companies or industries are most at risk?

Standard Chartered Plc estimates that 15 companies in four sectors accounted for 70% of stressed debt as of March 2020. Top on the list was telecoms, which held almost a third of the total. It’s being hit from a couple angles: subscribers are struggling to pay their bills and dropping contracts, and a court case over back fees has resulted in hefty fines. Utilities are also pressured as demand for power falls. Under Standard Chartered’s baseline scenario, which assumes about a 15% drop in earnings, stressed debt as a proportion of total debt could increase to 17%-19% by March 2021 from 14% this year.

4. Who delayed their payments?

Crisil, the Indian unit of S&P Global, analyzed over 2,300 non-financial companies of various sizes and found that 75% of those that took advantage of the moratorium on repayments were sub-investment grade. One in five companies in sectors severely hurt by the lockdown, including jewelry, hotels and capital goods along with utilities, availed themselves of the moratorium while only one in 10 did so from less-impacted areas such as pharmaceuticals, consumer staples and agriculture. The number of mid-size firms choosing the freeze was more than three times that of large firms.

5. How did it come to this?

The seeds were sown in India’s debt-fueled, economic boom between 2007 and 2012, when banks increased loans by 400%. When the growth rate began slowing more recently, many companies struggled to repay, making banks reluctant to lend more, creating a vicious circle. Some of the slack was picked up by the shadow banks, or non-bank lenders, but one of the most prominent — Infrastructure Leasing & Financial Services Ltd. — blew up in 2018 in what became known as India’s mini-Lehman moment. More rescues followed.

6. Is it all the banks’ fault?

No. Government policies played a role. Some borrowers found life harder when authorities suddenly tightened regulations, the courts canceled coal-mining licenses or ordered payment of telecom fees, natural gas supplies dwindled, real-estate prices fell and interest rates rose. Modi’s unprecedented decision in 2016 to overnight invalidate almost all of the nation’s physical currency devastated supply chains and created dangerous imbalances in the financial system as Indians rushed to deposit their cash. Making matters worse, there was long a belief among some corporate executives that they could walk away from debts without facing consequences. Regulators have alleged that some bank chiefs handed tycoons loans that ended up in default.

7. Will this move solve the problem?

Probably not but it will help buy time. About 70% of restructured debt eventually ends up in the bad-loan bucket, according to Standard Chartered’s study of historical data. However, this time it might be closer to 50%, the study said, because the conditions are stricter and time bound. Jefferies also predicts that about half of the restructured loans will end up as non-performing, which means as much as 4% of outstanding loans over the next two years. In the meantime, Crisil says the restructuring will help companies’ cash flow and protect their rating profiles. Reserve Bank Governor Shaktikanta Das has said banks should not expect further regulatory easing once the pandemic is under control.

8. What are the risks?

The Reserve Bank forecasts that the capital-adequacy ratio for lenders — a measure of available capital meant to ensure the bank can absorb a loss — could fall to as low as 11.8% by March from 14.6% a year earlier, close to the minimum requirement of 9%. To protect themselves and prepare for future business, most of India’s top private lenders such as Kotak Mahindra Bank Ltd. and ICICI Bank Ltd. have raised about $9 billion by tapping equity markets. However, most state banks — which account for more than two-thirds of bank credit — remain constrained and reliant on a cash-stretched government that’s unlikely to provide any funding this year. At the same time Modi’s administration is pushing state-run banks to lend more to small businesses and revive an economy that contracted 23.9% in the April-June quarter, the worst performance in data going back to 1996.

Source Article