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Last updated: 10 Feb, 2020  

msme-THMB-2010.jpg 'RBI's MSME loan restructuring signify shift in stance'

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SME Times News Bureau | 10 Feb, 2020

The RBI's latest decision on extending the MSME loan restructuring scheme and allowing relaxation in asset classification for certain real-estate projects signals a shift away from its earlier effort to enhance quality and transparency of asset classification by banks, Fitch Ratings said on Monday.

There is a risk that such regulatory forbearance will perpetuate moral hazard, as it follows aggressive lending growth and risk-taking in certain sectors in five years to the financial year ended March 2019, the ratings agency said.

"The Reserve Bank of India's (RBI) announcement of forbearance towards stressed sectors signifies a gradual shift away from the regulator's earlier effort to enhance the quality and transparency of asset classification in Indian banking system," it said.

"The RBI's extension of the one-time restructuring scheme for micro, small and medium-sized enterprises (MSMEs) and the announced relaxation in asset classification for certain real-estate projects mark a further dilution of the regulator's drive to enhance loan recognition.

"It is not clear at the moment whether this forbearance will be extended to non-bank financial institutions (NBFIs) as well, but we believe that the probability of this is high, considering the impact that the NBFI liquidity squeeze and a slowing economy have had on the MSME and real estate sectors. In recent years, banks have preferred to lend to NBFIs, which lend heavily to the real estate and MSME sectors, as a way to deploy their excess liquidity, while limiting their own direct exposure to these areas."

Fitch said it was unclear whether the latest announcement marks a substantial shift in the RBI's policy approach. "Nevertheless, it is not surprising in the current weak operating environment and is in line with a recent trend to weaken asset recognition standards. This was among the factors that prompted us to lower our operating environment score for India's banking sector in 2019."

Fitch believes that these extensions are only likely to defer asset-quality pressures unless there is a sustained improvement in macroeconomic conditions. "Although we expect India's economic growth to pick up in the coming months, to 5.6 per cent in FY21 from 4.6 per cent in FY20, there are still risks to the country's economic outlook."

Noting Indian banks have a poor track record with restructuring, it said that the RBI's asset-quality reviews in FY16 and FY18 found that a dominant share of loans restructured post-FY12 had degraded into non-performing loans (NPLs). "In that context, Fitch will make appropriate adjustments in order to objectively assess the performance of the underlying loan book of its rated entities in India to ensure their comparability with those of global peers."

The RBI's latest measures also nudge banks to lend more for specific purposes, namely automotive and housing purchases, and to the MSME sector. Banks can now knock off the equivalent of additional loans disbursed to these priority fields between end-January and end-July 2020 from their net demand and time liabilities for the purpose of calculating their cash reserve ratio.

The move is intended to improve monetary transmission, supporting credit to fields that have multiplier effects within the wider economy. However, most of these sectors have had above-average lending growth in the last few years, either directly or indirectly via non-banks, and could be at risk were the economy to slow. Moreover, these measures are unlikely to support sustainable credit growth until capitalisation improves meaningfully across banks, in particular among state-owned banks, which account for nearly two-thirds of the sector's assets.

 
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