Loan melas, regulatory forbearance may trigger fresh wave of bad loans

In a new set of measures to boost credit growth, the government has asked public sector banks (PSBs) to go on a lending spree and overlook non-repayments to support stressed micro, small and medium enterprises (MSMEs) sector.   

The so called “loan melas” are outreach camps that lenders will be setting up in 400 districts of the country, with focus on retail and agriculture loans as well.

While it is unclear how the measures will help the sector, it is definitely bad news for PSBs, that are still not out of the woods in terms of asset quality.

“Relief to MSMEs and more and easy loans to retail borrowers can provide a short term fillip to demand and growth in the short term. But this initiative is fraught with the risk of potential non-performing assets (NPAs) in the medium to long term,” VK Vijayakumar, Chief Investment Strategist at Geojit Financial Services.

Ironically, the announcements came a week after an internal working group set up by the Reserve Bank of India (RBI) to review agricultural credit warned about the repercussion of loan waivers. While the government’s measures have not asked banks to waive off the entire loan, the one-time forbearance may raise their hopes and defaults in anticipation of such a move going forward.

“This is sizeable negative for all the banks – possibility of wilful defaulters will increase meaningfully and credibility of balance sheets of banks will reduce as it will undermine the actual NPA stress on the books,” said Anusha Raheja, BFSI Research Analyst at LKP Securities. “Also dilution of credit risk norms while giving additional credit via PSBs to retail, agri and MSME sector is one of the major risk,” he added.

Aditya Narain, head of research at Edelweiss Securities pointed out that the economic slowdown was related to lack of demand in the economy, and not because banks are not ready to lend.

Also, government’s measures to cut corporate taxes may boost earnings, cash flow from a medium-term perspective, Narain said that turning business cycle could still remain challenging.

“While it should ease some asset quality stress and support deleveraging, it remains tough for MSMEs as they do not get tax benefits (their tax rate is already at 25 percent)—it will be a slow grind. The stimulus is on the way, but economic impact will be lagged,” Narain said.

A report by Edelweiss Securities showed that the debt growth in MSME sector is much higher than their output. As per RBI data, bank credit to MSMEs stood at Rs 27.98 lakh crore as on July 19, higher by 6.1 percent a year ago.

According to a report, some PSB executives had expressed reservations on Finance Minister Nirmala Sitharaman’s proposals of holding public camps for distributing loans in 400 districts of the country, in a meeting held last week. Their fears emanate from experience of such “loan melas” in the regime of the previous government.

Also, the forbearance on bad loans isn’t anything new. It already existed since the start of 2019 but, largely, banks did not opt to avail the exemption as it attracted higher provisioning.

On January 1, RBI issued a circular permitting a one-time restructuring of existing loans to stressed MSMEs as ‘standard’ without a downgrade in the asset classification. RBI asked banks to make additional provisioning of 5 percent for such accounts.

“Banks will, however, have the option of reversing such provisions at the end of the specified period, subject to the account demonstrating satisfactory performance during the specified period,” RBI said.

Also, the RBI clarified that while accounts already classified as NPA can be restructured, the extant asset classification norms governing restructuring of NPAs will continue to apply.