Bad Bank and the role it will play for small financial banks
The creation of the National Asset Reconstruction Company (NARCL) is a welcome move for the banking sector, which has been reeling under the weight of bad debts. An overall assessment of the future of bad loans in India revealed that non-performing assets (NPA) are expected to increase in the near future and peak in 2022-23, estimated at 10-13% of the loan portfolio.
The Reserve Bank of India (RBI) has introduced a Rapid Corrective Action (PCA) framework for large NBFCs, introducing restrictions whenever key metrics drop below a set threshold. Among other things, the PCA framework set the first NPA threshold at 6%. This is where I think NBFC would be vulnerable, and it will require them to be conservative.
While the intent behind RBI’s introduction of APC is understandable, it is important to recognize that NBFCs play an important intermediation role and often fill funding gaps when banks falter. Thus, by their very structure, NBFCs should take more risks and have higher NPAs. Will the introduction of APC next year force NBFCs to change their business model? We will have to wait and watch.
The pandemic, while having created opportunities for growth, has not been too kind to small and medium enterprises and has impacted SFB NPA levels. Before the pandemic, NPAs for small financial banks were around 2%; reasonably good given the profile of the borrowers. However, after the pandemic, the ratio increased to around 7%. With the anticipation of another wave of COVID, in March 2022, SFBs could look to double-digit NPAs. High capital buffers add an extra layer of cushion for SFBs, and most should be able to digest this loss. However, capital that was earmarked for growth and used for funding and amortization is not its best use. This will push SFBs into alternatives, including selling NPAs.
However, the pandemic has breathed new life into ARCs and they are crafting their new avatar. As banks look to transfer larger NPAs to NARCL, many CRAs are now changing direction and considering acquiring smaller loans. The disruption caused by the pandemic has caused many good small and medium-sized businesses to close and therefore default on loans. However, they are inherently good companies and CRAs believe that pooling assets can contribute to a stronger recovery.
Additionally, acquiring smaller-ticket NPAs (including retail) is difficult and highly dependent on technology support. SFBs, which are relatively smaller and nimble, have a strong technology implementation and are able to monitor the portfolio more closely than many large banks. This makes it a prime candidate for CRAs.
Considering the size and demographics of India, SFBs play an important role. A strong regulatory framework should only be an enabler and SFBs should be motivated to go where the big banks have failed. Dissemination of credit to low income groups and the weakest section is important to achieve sustainable high growth and income equality. Access to NARCL and ARCs will incentivize smaller financial banks to take on more risk without unreasonably caring about capital.
The author Tarun Bhatia is MD and director of Kroll South Asia. The opinions expressed are personal.
(Edited by : Kanishka Sarkar)