The bad loan rate of banks stood at 7.5% as of March 2021, having fallen from 8.4% as of March 2020. When it comes to public sector banks, the bad loans rate stood at 9.5% against 10.8% a year earlier. Bad loans are loans that haven’t been repaid for 90 days or more. The ratio of bad loans as a proportion of overall loans is called the bad loan rate.
In every FSR, among other things, the RBI also forecasts the bad loans rate under different scenarios in the time to come. This time around, RBI has forecast that the bad loans rate of banks will increase to 9.8% by March 2022 under the baseline scenario and to 11.22% under a severe stress scenario.
This is very optimistic compared to the RBI forecast in the last FSR report published in January. In it, the central bank expected the bad loan rate to touch 13.5% by September 2021 under the baseline scenario and 14.8% under the severe stress one.
The RBI has revised the bad loans rate forecast downward in the latest FSR, from 13.5% in September to 9.8% in March 2022. This is in line with recent communication by the central bank, where it has tried to project positivity amid economic gloom and doom.
Take, for instance, the latest State of the Economy report, where the central bank had quoted Winston Churchill as saying: “a pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty.” Nevertheless, it’s not the central bank’s job to be optimistic or be pessimistic. Its job is to call things as it sees them.
Over and above this, the several loan restructuring schemes launched by the RBI would have helped kick the bad loans can down the road. Restructuring a loan involves extending the loan’s maturity, thereby reducing the regular payment of interest and regular repayment of principal that need to be made. It can also simply involve reducing the interest charged on a loan.
In the past, banks and bankers have also extended and pretended. This is a favourite technique of bankers and is referred to as the evergreening of loans. This involves giving a new loan to the borrower to pay the interest on the original loan or even repay it. And then everyone can pretend that all is well. This happened quite a lot between 2011 and 2014 when the bad loans from the previous lending binge were growing, but the banks were not recognising them.
Nevertheless, as the former RBI governor Raghuram Rajan put it in his November 2014 speech: “mutilating Shakespeare, an NPA by any other name smells as bad!”
Also, RBI has had a terrible record on the forecasting front. For example, look at the following chart. It plots the RBI’s forecast of what it expected the bad loans rate to be under the baseline scenario and the actual bad loans rate as it turned out.
The above chart makes for very interesting reading. From March 2014 to March 2018, when the bad loans rate of Indian banks was going up, the RBI constantly underestimated the rate. After that, as the bad loans have come down, it has constantly overestimated them.
This cycle should be turning now, given the negative economic impact that covid has had on the country’s economy. For example, take the case of the bad loans rate of public sector banks when it comes to lending to micro, small and medium enterprises. As of March 2021, it stood at 15.9%, having jumped from 13.1% as of December 2020. This is despite the multiple restructuring schemes launched by the RBI over the last few years.
Given this, RBI’s past forecasts on the bad loans rate front do not inspire much confidence. As a former chief economic adviser to the ministry of finance Arvind Subramanian puts it in his book Of Counsel: “For years, the RBI was unable to grasp the seriousness of the loan repayment problems or identify the prolonged frauds of Nirav Modi… In March 2015, the RBI was forecasting that even under a “severe stress” scenario—where to put it colourfully, all hell breaks loose, with growth collapsing and interest rates shooting up—NPAs [bad loans] would at most reach about ₹4.5 trillion.” By March 2018, the total bad loans of banks had stood at ₹10.36 trillion.
While forecasting the exact figure is impossible, RBI has been way off the mark. One possible reason can be offered in the RBI’s defence. Let’s assume that the central bank in March 2015 had some inkling of banks’ bad loans ending up at around ₹10 trillion. Would it have made sense to put out such a massive number as the country’s banking regulator? Putting out numbers like that could have spooked the banking system in the country, something that the RBI, as the country’s banking regulator, wouldn’t want.
In this scenario, it perhaps made sense for the regulator to gradually up the bad loans rate prediction as the situation worsened than predict it in just one go. But, of course, one has no insider information on this, and this logic has been offered just to give the country’s banking regulator the benefit of the doubt.
The trouble is, it is making the same mistake all over again.
Vivek Kaul is the author of Bad Money.
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