“The first lesson for policymakers is to treat emergency measures as such and not to extend them even after recovery: when an emergency medicine becomes a staple diet, it can be counterproductive,” the survey said.
The document highlights that Indian regulators should not repeat the mistake that it had made during and after the 2008 Global Financial Crisis. The authorities took a lot of time to end the emergency measures that resulted in a bad loan crisis, which is still is far from over.
“During the 2008 crisis, forbearance helped borrowers tide over temporary hardship caused due to the crisis and helped prevent a large contagion. However, the forbearance continued for seven years, though it should have been discontinued in 2011, when GDP, exports, IIP and credit growth had all recovered significantly,” the survey said.
Currently, Indian financial entities are barred from recognising bad loans by the Supreme Court until further orders. However, some banks claim they have provided adequately for the impending rise in non-performing assets.
The survey said a clean-up of bank balance sheets is necessary when the forbearance is discontinued. It said an asset quality review (AQR) exercise must be conducted immediately after the forbearance is withdrawn so that a real picture of bad loans can be gauged.
Public sector banks may be at a disadvantage if and when this happens. RBI in its projections has said gross NPA ratio of public sector banks may rise 650 basis points to 16.2 per cent by September 2021 under the baseline scenario. And, if the situation worsened, the ratio may rise to 17.6 per cent, the central bank said.
“The asset quality review must account for all the creative ways in which banks can evergreen their loans. In this context, it must be emphasized that advance warning signals that do not serve their purpose of flagging concerns may create a false sense of security. The banking regulator needs to be more equipped in the early detection of fault lines and must expand the toolkit of ex-ante remedial measures,” it said.
It said the clean-up of the balance sheet must be accompanied with capital infusion.
“A clean-up exercise should be accompanied by mandatory recapitalization based on a thorough evaluation of the capital requirements post an asset quality review. Apart from recapitalizing banks, it is important to enhance the quality of their governance,” it said.
