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Ok, Tell them your NPAs, says the Court. Will all hell break loose now?


Almost exactly a year ago when the COVID-19 pandemic hit life as we know it like a sledgehammer, the Reserve Bank of India announced a moratorium on loan EMIs, at that time, for a period of three months. We wrote a simple explainer on this [3 Months of no EMIs, But why you should pay if you can].

The moratorium was then extended to six months. But everyone including borrowers, lenders and everyone in between has been confused about who owes what, to who.

The Government then issued a clarification on waiving “interest on interest”, which led to people receiving credits in their bank accounts, and we wrote about that too [Is there an ex-gratia amount of money paid to your account? Here’s why]

Now, the Supreme Court has finally come out with its order on two things:

  • are we allowed to call anything an NPA (bad loan) anymore?
  • does a moratorium for Covid last year mean no interest?

The answers are: yes, be our guest; and no, are you out of your mind.

But not in that tone because this is the Supreme Court. We explore.

NPAs are back in fashion again!

The Supreme Court had said that no bank or NBFC could call any bad loan an “NPA” after August 31, even if the person or company had not paid back the loan due amount.

This had resulted in all banks and financiers announcing results which were much better than one would have anticipated, but the RBI forced banks to announce “pro forma” NPAs, which means what they would have reported if there was no supreme court order restricting them.

This “leeway” has now been removed:

“Interim relief granted earlier not to declare the accounts of respective borrowers as NPA stands vacated.”, says the Supreme court order.

This means the banks can start reporting NPAs as they would, starting with the March 31 quarter. All loans that are 90 days past due as of March 31 will be reported as NPAs

This changes a few things. According to ICRA (link) total bad loans in the system were reported at 7.4 lakh crore. This will now go up to about 8.7 lakh crore – an increase of Rs. 1.3 lakh crore due to the the supreme court order that allows banks to tell us the real situation.

Net NPAS – that is, net of provisions – are also going to be up by Rs. 100,000 cr.

The combination means that while banks have provisioned in part for the supreme court order, there’s not enough out there. Remember the RBI did mention earlier that bank NPAs were likely to touch as much as 13.5% overall in September 2021. (link)

RBI Stress Test for Banks Showing High Stress


Forget the medium and severe stress situations – just the baseline is quite horrendous. Even private sector bank NPAs will double. Effectively, bad loans will become over 14 lakh crore (at 13.5%) . However, what’s good is that banks seem adequately capitalized.

Also, banks have been given time till March 31, 2021 to restructure troubled loans. From what we hear so far, nothing major has come through in terms of restructuring. This is a problem – banks are refusing to restructure so as to not show losses, but this means they are being stubborn and not working hard to recognize the problem. On the other hand, corporates are used to making banks take losses, so they might be trying to be too aggressive in pushing the problem to banks. Both these are probably going to make banks more vulnerable.

Lastly, the Bankruptcy actions had been paused for a  year. That gets restarted on April 1, 2021. This will allow banks to take companies to bankruptcy immediately, and that will cause the stress in any company to get visible.

What this means is:

  • The really bad stuff is coming and ahead of us.
  • Banks will see a lot more NPAs. Starting from next month, you will see reports of higher numbers.
  • If there are NPAs, then there must be defaults. We will hear more of them.
  • Even though interest rates were low, recent rising yields means that the cost to borrow for corporates is going up. This will hurt recovery.
  • Banks and corporates are probably not seeing the magnitude of the problem if they don’t amicable resolve the situation – and we will see more companies dragged into bankruptcy.

Stock markets are not really bothered. Perhaps this is overkill, and perhaps it’s not. However, it’s important to understand risks to the system as they happen.

The second thing: All Loans gets interest-on-interest waived

The part about the interest-on-interest: The court said listen, we won’t waive off any interest that was to be paid. But interest on interest – compound interest essentially – is not allowed for the moratorium. The government had earlier paid for such interest on interest (you might have seen an amount even for your credit card outstanding) but only for specific accounts with less than 2 cr. in loans:

“Therefore, we are of the opinion that there shall not be any charge of interest on interest/compound
interest/penal interest for the period during the moratorium from any of the borrowers and whatever the amount is recovered by way of interest on interest/compound interest/penal interest for the period during the moratorium, the same shall be refunded and to be adjusted/given credit in the next instalment of the loan account.”

This means that either the government, or the banks, have to deal with a situation where any compound interest must now see a return of money to the borrower, if interest on interest was charged in the period between March 1 and August 31, 2020.

  • This will not apply to new loans taken after March, apparently
  • This reversal is only if compound interest was charged. If a company or person didn’t take the moratorium and paid back on time, they don’t seem to get any benefit
  • The amount, says ICRA, even if all of the loans were taken into account – is about Rs. 7,500 cr. in total. Which isn’t huge by the scheme of things.

The Supreme Court though, has said a few things – it doesn’t intend to waive off interest at all (only the interest-on-interest) and it admits that the court is not the place to make way for financial relief, that is more for the executive and the RBI.

But the question really is: does the Supreme Court have to do these things? It seems to have just created administrative work for no real impact to anyone.

Now, to focus on the real economy

The economy isn’t in great shape. It appears to be, via the stock markets, but underlying this is some very simple logic:

  • Bank credit is still only growing at 6.6% a year. This is after the RBI has gone ballistic printing money
  • Bond yields have gone up substantially – from a 5.8% on the 10 year bond a few months back, to nearly 6.15% today. This has increased interest rates in the system for longer term borrowers.
  • Inflation sounds high but with the recent retreat of oil prices back to below $65, we are likely to see a moderation in prices
  • Petrol and Diesel consumption are falling, with February seeing contraction on a year on year basis
  • Covid cases are going up all over the country, and the second surge may easily lead to more lockdowns.

What this means is that the situation in credit and fixed income can become tricky once more in the rest of the year. Our first stop is to look at bank results this time. As commentary sets in, we may be able to figure out which lenders may not be in the best of shape.

The Supreme Court may have washed its hands off an affair it cannot easily understand. But to the rest of the economy, the fact remains that Covid has weakened the most vulnerable sectors, and hurt jobs, employment and growth. Even as we limp back into shape, the collateral damage in terms of defaults, NPAs and a cascading impact of bankruptcies has yet to hit us. Watch out for the next six months.

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