Daily News Analysis

RBI Annual Report

31st May, 2021 Economy

GS PAPER III: Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment.

Context: In its semi-annual financial stability report, RBI said that the bad loan ratio of banks could rise to 13.5% under the baseline stress scenario by September 2021.

  • The Reserve Bank of India (RBI) said that asset quality of the banks would need close monitoring along with their preparedness for higher provisioning in coming quarters.
  • The regulator has cautioned banks to show true picture of bad loans after Supreme Court lifted interim stay on classifying non-performing assets (NPA) in March 2021.
  • RBI said that the waiver of compound interest on all loan accounts which opted for moratorium during March-August 2020 may also put stress on banks’ financial health.
  • The regulator is of the view that banks are better positioned than before in managing stress in their balance sheets thanks to higher capital buffers, improvement in recoveries and a return to profitability.
  • Stress tests indicate that Indian banks have sufficient capital at the aggregate level even in a severe stress scenario.
  • Bank-wise as well as system-wide supervisory stress testing provide clues for a forward-looking identification of vulnerable areas.
  • Prudent provisioning by banks, even over and above regulatory prescriptions for accounts availing moratorium and undergoing restructuring, resulted in an improvement in the provision coverage ratio (PCR) of banks.
  • Provision coverage ratio has improved to 75.5% at December-end 2020 from 66.6% in March 2020.
    • Provisioning Coverage Ratio (PCR) is essentially the ratio of provisioning to gross non-performing assets (NPA) and indicates the extent of funds a bank has kept aside to cover loan losses.
  • The capital to risk-weighted assets ratio (CRAR) of banks rose to 15.9% by end-December 2020 from 14.8% at end-March 2020.
    • CRAR also known as Capital Adequacy Ratio (CAR) is the ratio of a bank's capital to its risk. CRAR is decided by central banks and bank regulators to prevent commercial banks from taking excess leverage and becoming insolvent in the process. The Basel III norms stipulated a capital to risk-weighted assets of 8%.
  • The capital adequacy ratio of banks was aided by capital raising from the market by public and private sector banks, and retention of profits.
  • The report also said that gross NPA ratio for non-banking financial institutions (NBFCs) improved to 5.7% in December 2020 from 6.8% in March 2020.
  • Similarly, the capital adequacy ratio of NBFCs marginally improved to 24.8% in December 2020 from 23.7% during the same period last year.

What is a Non-Performing Asset?

  • A non-performing asset (NPA) is a classification used by financial institutions for loans and advances on which the principal is past due and on which no interest payments have been made for a period of time.
  • In general, loans become NPAs when they are outstanding for 90 days or more, though some lenders use a shorter window in considering a loan or advance past due. Lenders usually provide a grace period before classifying an asset as non-performing.

NPA is categorized into the following sub-categories:

Standard Assets

  • They are NPAs that have been past due for anywhere from 90 days to 12 months, with a normal risk level.

Sub-Standard Assets

  • They are NPAs that have been past due for more than 12 months.
  • They have a significantly higher risk level, combined with a borrower that has less than ideal credit.

Doubtful Debts

  • Non-performing assets in the doubtful debts category have been past due for at least 18 months.
  • Banks generally have serious doubts that the borrower will ever repay the full loan. This class of NPA seriously affects the bank’s own risk profile.

Loss Assets

  • These are non-performing assets with an extended period of non-payment.
  • With this class, banks are forced to accept that the loan will never be repaid, and must record a loss on their balance sheet.
  • The entire amount of the loan must be written off completely.