COVID-19 has cemented its place in the world history for having significantly impacted the global financial markets, including India. As Coronavirus continues to spread, and more information comes to light, the banking sector over the next two quarters is expected to have a tough time. It is a no-brainer that the lockdown imposed and the prolonged shutdown / skeletal working of the all establishments will lead to a possibility of new NPAs [Non Performing Assets]; not to mention few industry sectors like the tourism, entertainment and hospitality which are still awaiting their sunrise. Small business, which are already less on cash will face the massive hit due to the prevailing situation
COVID-19 may impact the Indian Banking sector in a significant way, banks will witness a precipitous rise in non-performing assets, both from the private corporate and the retail sectors as firms and households struggle to deal with this unprecedented shock. A large number of firms especially the micro, small and medium businesses and also self-employed individuals are likely to default on their bank loans.
What Banks want
- Deferment of loan instalment for 6 months
- Bad Loan recognition after 180/270 days, up from 90 days
- 6 Month extension of cases under Inter Creditor agreements
- No Classification of NPA for 2 months
- Hike Partial Credit Guarantee limits
- Long-term line of credits
- Sovereign Guarantee for worst hit sectors
- Credit rating reviews on hold
The Reserve Bank of India slashed interest rates, following other central banks that have taken emergency measures to counter the economic fallout from the fast-spreading coronavirus pandemic.
The RBI has decided to retain its accommodative stance as long as necessary to revive growth and mitigate the impact of coronavirus on the Banking & Financial institutions, while ensuring that inflation remains within the target.
- RBI cuts the Repo Rate by 75 basis point (from 5.15%) to 4.4%
- Marginal Standing facility (MSF) rate & Bank Rate stand reduced to 4.65% from 5.40%
- Reverse Repo Rate has been reduced by 90 Basis points to 4%
- CRR of all banks to be reduced by 100 basis points to 3%
- Banks to allow 3-months moratorium on all loans; Loan interest payment to be deferred by 3 months
- RBI will inject liquidity of Rs.3.74 lakh crores to the system
We are living through an extraordinary and unprecedented situation, in terms of both the depth and the duration. The pandemic has affected almost every state / nation and the rate at which it is spreading is alarming. Clearly, the efforts being taken are never heard of and pushes everyone to think outside the box and bring out innovate ways to curb the spread and combat the virus. All commercial banks, including regional rural banks, small finance banks, local area banks, cooperative banks, financial institutions and non-banking finance companies, including housing finance companies and micro-finance lenders will still have impact that can be broadly classified into Short-term (4-6 months) and Long-Term (More than 6 months)
Short-term impact (4-6 months)
- High Capital Losses: Several Banks might suffer moderate to heavy capital losses in the near future. Risk-weighted assets (RWA) are expected to be impacted by higher charges from increased volatility levels and higher counterparty risks. Potentially less favourable economic outlook might negatively impact the loss allowances. In addition, borrowers may want to refinance at longer maturities to lock in lower interest rates. Financial institutions might have to put their growth targets on the backseat due to these losses, as it would require raising additional funds.
- Decreased Operational Efficiency and Lower Revenues: As the pandemic advances, the temporary closure of branches and employee absences will impact operations. This might affect lead generation and the sales pipelines, thus slowing down business for multiple quarters. There might be an increased demand for cash in the near future due to the effect on replenishment schedules. In case of interest rate cuts, banks’ net interest income and fee income is expected to be challenged. Due to lower offtake and other pressures, such as lower asset under management and lower investment activities, banks could face de-growth scenarios.
- Liquidity Crisis: Some banks’ contingency funding plans (CFPs) may have already been invoked. Moreover, due to market volatility, there could be significant swings in stress testing results and limit/threshold breaches. Some market participants may already be experiencing increased liquidity tightening situations. With a sudden halt in cash inflows in the form of loan repayments, there might be a possible scenario of liquidity imbalance leading to an asset liability mismatch. Financial institutions may be required to sell assets not intended to be sold under regular market conditions to cover the sudden liquidity shortfalls. A sharp drop in interest rates and increased volatility in securities and foreign exchange prices may increase the institutions’ market risk.
Long-term impact (More than 6 months)
- Higher Delinquencies and Higher Capital Requirements: Impediment in cash flows can lead to loan default by various sectors impacted by the pandemic. Banks are already staring at exposure in sectors, such as hospitality, shipping, transport, tourism, and aviation. This is bound to increase until business stability is attained. Under the current regulations, non-performing assets reported by these institutions may see a surge in the first quarter of FY21. A subsequent decrease in shareholder value can result in selling off securities and redemption through mutual funds, thus impacting the liquidity of Banks. With clients potentially experiencing stressed financial conditions, credit quality/ratings may be impacted.
- Decreased Profitability: Continued business slowdown can cause a significant decrease in profitability and consequently a decrease in the earnings before interest, tax, depreciation, and amortization (EBITDA). This could result in loss of investor confidence in the institution and further strain the existing woes with respect to funding. Any future growth plans would consequently be affected and might be in need of deferment, as the institution would need to focus on improving margins and top line growth.
- Non-Financial Risks: Banks are exposed to various other non-financial risks, such as conduct risk/culture, brand risk, model risk, third-party risk, and cyber risk that may or may not have any financial impact in future. If a bank’s operating model needs to change, it may become difficult for the boards of these Banks to continue to meet governance obligations, such as overseeing risk, providing credible challenges to the management, and acting as responsible stewards of the institution. These challenges are expected to translate into high capital infusion requirements for the financial institutions to maintain both regulatory capital and growth capital.
The long-term implications of the pandemic for the Indian Banking Sector are unknown. When normalcy returns, Banks are expected to have learnt a few lessons, including how to best retain operational resilience when confronted with future pandemics, and possibly, how to redesign new operating models such as alternate work arrangements. The pandemic may further accelerate migration to infrastructure of the future– digital channels and connectivity.
- Embracing New Technologies – Indian Banking sector has already realized the role of technology in achieving the reach and scale. Experts foresee higher rates of adoption of micro-service architecture by dropping vertically integrated stacks, APIs, containerization, cloud computing, AI and blockchain. These technologies will play critical roles in digital transformation of Banks and re-imagine digital delivery of services.
- Channels of Digitization – India is home to the world’s second largest unbanked population at 190 million adults without access to a bank account. With the reach of the mobile and network spreading like wild fire, the crucial focus area could be to step up the digital financial inclusion powered by the technology. Banks will enable its customers to interact over multiple automated and digital channels to offer the optimal channel mix.
- Security, Privacy and Customer Trust – In the FY 2017-2018, India’s banking sector witnessed an increase in cyber frauds and incurred $ 13.7 million loss. With increased use of cashless and digital economy, it will be imperative for the banks to implement secure frameworks and systems. The most common security risks include but not limited to money laundering, data breach, Loss of personal information and monetary frauds. Banks should be technically strengthened by rigorous KYC, strong customer authentication (SCA), financial grade APIs, firewalls, smart networks, etc., for secure and seamless transactions. Robust banking solutions and cyber security initiatives help safeguard against malicious attacks.
- Policy and Compliance – The focus should be on increased digital payment infrastructure, especially in rural India, with an intention to create a financial ecosystem for the unbanked and underbanked population of our country. From a security and privacy standpoint, India is already on its path to introduce the Personal Data Protection bill (PDP) on the lines of GDPR in the EU. This bill protects personal information of consumers including sensitive financial information. It would be in the best interest to implement stringent penalties on erring entities found in violation of the bill
The COVID-19 impact on the global and Indian Banking systems will be phenomenal and multifold. It is important to take the long view and prioritize accordingly.
For Indian banks particularly – resilience, driven by digital agility is a way to achieve relevance and success on the other side of COVID-19.
Abhijit Ajit Samant
Head of Sales at NCS Soft, Abhijit has more than 15 years of rich & specialised experience in Business Development, Sales-Pre Sales both at India & overseas markets of the Banking & Financial Services Domain. He holds a Post-Graduation in Marketing (PGDBA). A keen strategist, planner and implementer with expertise in devising strategies aimed at enhancing overall organizational growth, sustained profitability of operations and improved business revenue.