[Editorial Analysis] Stress test

Mains Paper 3: Economy
Prelims level: Financial Stability report
Mains level: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment

Context:

• In March 2020, the Reserve Bank of India had announced a moratorium on the repayment of all term loans for both businesses and households, to ease their burden during the period of the lockdown.

• Initially allowed for a period of three months, it was subsequently extended till the end of August 2020.

Financial Stability report:

• Data from the RBI’s latest financial stability report shows that at the end of April around half of the customers of scheduled commercial banks, accounting for half of the outstanding bank loans, opted to avail of the relief measures extended.

• Public sector banks shouldered a disproportionate burden of the moratorium with roughly two-thirds of borrowers availing of the facility, as opposed to less than half in the case of private banks.

• In subsequent months, as economic activity picked up following the relaxations of the restrictions, there has been an improvement in the situation, with those availing of this facility dropping steadily.

Gross Npas:

• According to the financial stability report, NPAs were on a downward trajectory before the COVID shock.

• While the economic slowdown is likely to adversely impact banks’ non-performing assets, greater clarity on the bank’s asset quality will emerge only once the moratorium period ends.

• While this is still some time away, the RBI has conducted a series of stress tests to project the possible impact of the economic shock on bank balance sheets.

• According to its estimates, banks’ gross NPAs may rise to 12.5 percent by March 2021, up from 8.5 percent in March 2020, if the economy contracts by 4.4 percent this year.

• However, if the contraction worsens to 8.9 percent, which some analysts are projecting, bad loans could rise to 14.7 percent.

• Public sector banks are likely to witness a larger spurt in bad loans than their private sector counterparts, though the impact on the NBFCs/HFCs is also expected to be substantial.

• In the extreme scenario, five banks are unlikely to meet the minimum capital requirements, underlining the urgent need for banks to raise capital.

Extending the moratorium:

• Owing to its fiscal constraints, the government is unlikely to recapitalise banks to the extent required.

• However, there is the possibility of the RBI extending the moratorium period or opting for a one-time restructuring of loans, especially for the stressed sectors.

• The latter will push back the requirement of banks having to raise additional capital.

• Prodding banks to ramp up lending despite data indicating their unwillingness to take on the credit risk in the economy, could further adversely affect their balance sheets.

• This weakness in the financial sector could slow down the economic recovery.

Key Concepts:

• Moratorium period refers to the period of time during which you do not have to pay an EMI on the loan taken. This period is also known as EMI holiday. Usually, such breaks are offered to help individuals facing temporary financial difficulties to plan their finances better.

• A nonperforming asset (NPA) refers to a classification for loans or advances that are in default or in arrears. A loan is in arrears when principal or interest payments are late or missed. A loan is in default when the lender considers the loan agreement to be broken and the debtor is unable to meet his obligations.

• Regulatory capital is the minimum capital requirement as demanded by the regulators; it is the amount a bank must hold in order to operate. A regulator’s primary concern is that there is sufficient capital to buffer a bank against large losses so that deposits are not at risk, with the possibility of further disruption in the financial system being minimized. Regulatory capital could be seen as the minimum capital requirement in a “liquidation / runoff” view, whereby, if a bank has to be liquidated, whether all liabilities can be paid off.

• Capital Adequacy Ratio is also known as Capital to Risk Assets Ratio, is the ratio of a bank’s capital to its risk. National regulators track a bank’s CAR to ensure that it can absorb a reasonable amount of loss and complies with statutory Capital requirements. It is a measure of a bank’s capital.

Conclusion:

• RBI’s financial stability report underlines weakness that must be addressed, or it could slow down economic recovery.

———————————————

Prelims Questions:

Q.1) With reference to the National Statistical Office (NSO) report on “Household Social Consumption: Education”, consider the following statements:

1. On Accessibility to schools, 92.7% of the rural households have a primary school within 1 km as compared to 87.2% in urban areas.

2. The all India literacy rate among persons aged 7 years and above is 77.7%.

Which of the statements given above is/are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2

Answer: C

Mains Questions:

Q.1) Write short note on following: Moratorium period, Capital Adequacy Ratio, Regulatory capital, Nonperforming asset.

Subscribe to Get Weekly updates

Get daily current affair video, detailed current affairs PPT for quick revision and Free One Liner PDF directly in your inbox. Subscribe now to get this month's one liner for FREE.