Managing bad loans

Context: The economic disruption due to the COVID-19 pandemic is likely to worsen the non-performing assets (NPAs) situation in the banks. Bank balance sheets would need to be quickly repaired.

Factors cautioning rise in NPAs

• Impact of COVID: 

• Due to the contraction in economic activity: affecting the revenues and the ability of businesses to repay debt. Firms with stalled projects would find it difficult to service loans.
• Increased borrowing by the households due to COVID related hardships.

• Suspension of Insolvency and Bankruptcy Code: would affect the bargaining powers of the lenders.
• Slow rebound in economic activity: escalate the pain in the banking system and in turn, affecting the economy as banks are the principle source of debt financing in India.
• Impaired state of banking: Public Sector Banks was not in good shape before the crisis, they never recovered from the financial crisis and excessive lending in its aftermath.

Steps taken by RBI to manage bad loans

• Asked banks to conduct detailed stress tests: evaluating the quality of books and accounts so that they might be forced to raise more capital.
• Initiated discussion with the banks: as some of the regulatory flexibility may be warranted in the current economic situation.
• Infused liquidity into the system: to aid the functioning of the bond market. 

Way Forward:  

• Role of Government: To infuse more capital into public sector banks.

• Role of RBI:

• Review the trigger points for additional provisioning.
• Relax rules for a short period to accommodate difficulties arising because of the pandemic.
• Allow a one-time restructuring of loans.
• Carefully relaxing regulations ensuring bad assets are not hidden.