Taking matters further, in this impact analysis we will discuss the NPA situation and exposures in the banking sector as pointed out by the Financial Stability Report (December 2018) & Report on Trends and Progress of Banking in India. The analysis starts with the assessment of the NPA and stressed loan scenario and moves to the dissection of loan exposures and industry wise risk. Finally, we examine the stress tests that are conduct ed by RBI staff using key variables to model risk.

NPA and Stressed Loans: Among large borrowers, the percentage change in SMA2 has been recorded at 58.6% between Q1 & Q2 FY19, a period when all other segments such as SMA0, SMA1 and RSA have showed declines

As per these reports, the GNPA level had increased to 11.2% of NDTL by FY18 (as on March 2018) as compared to 9.3% same time last year. Public Sector Banks (PSBs) were the most prominent influencer of this number as their GNPA share went up by almost 300 bps as compared to the previous year; PSB GNPA was therefore recorded at 14.6% in FY18. Private Banks (PVB) and Foreign Banks (FB) GNPA remained stable with minor deviations. However, the recent Financial Stability Report states that as of September 2018 (end Q2 FY19), the quantum of GNPA came down by 40 bps overall, due to the better realizations and a slower growth, which is recorded at around 10%. Interesting to note, while 23 of the 55 (42%) banks considered have a GNPA in the range of 0-5%, 15 banks are in the range of 15-30%.

In terms of classifications of loan assets, Standard Assets were recorded at 88.5% (Rs. 74,022 billion) in FY18 as compared to 90.4% (Rs. 68,624 billion), same time last year. The PSBs again were the worst hit in this department as their standard assets went down by 300 bps; those of PVB and FBs remained more or less stable. Incidentally, an eclectic picture emerged in the large borrower account category, which is an important indicator of the overall stress in the system. Here, even though the overall NPA in the category went down by 150 bps (21.6%) for PSBs and 90 bps (7%) for PVBs by Q2 FY19, there were other segments that demanded more attention. Restructured Standard Advances (RSA), for instance went down to 2.2% in Q2 FY19 as compared to the highs recorded in Q4 FY17 (5.5%). What this means is that lower number of accounts could be restructured over the time period and the transition to NPA status was slower. This can be seen in the increases in the SMA-2 segment of the category.

The SMA2 segment is perhaps a very important consideration here because it precedes the NPA classification by just one notch. Therefore, not unanticipated, among large borrowers, the percentage change in SMA2 has been recorded at 58.6% between Q1 & Q2 FY19, a period when all other segments such as SMA0, SMA1 and RSA have showed declines. The situation deserves a special mention here because it shows the buildup of stress among large borrower accounts, which may slip to NPA in the new financial year. For record, the segment also grew to 1.1% (all SCBs) of all advances in September 2018 from under 0.7%, recorded in Q4 FY18.

Industry Exposure:As a caveat, one must consider that most of the credit expansion in the manufacturing sector has been fueled by working capital loans and refinancing, we reckon that fresh loans (term) are still difficult to source as banks become increasingly risk averse

Discussing the sectoral deployment of Gross Bank Credit, it is noticed that Agriculture & Allied Activities has somewhat recovered by Q2 FY19. As compared to a growth of 3.8% recorded by the end of Q4 FY18, the exposure to the sector accelerated to 5.8%. Same goes for Industry, the exposure to which expanded by 2.3% in Q2 FY19 as compared a meagre 0.7% in Q4 FY18. A significant gainer here has been the large industries segment, exposure to which increased by almost 3% in the most recent quarter, as compared to 0.8% recorded in March 2018. The manufacturing MSME segment on the other hand languished further as it experienced a de-growth of (-) 1.4% in September as compared to nearly 1% credit expansion recorded in March. As a caveat, one must consider that most of the credit expansion in the sector has been fueled by working capital loans and refinancing, we reckon that fresh loans (term) are still difficult to source as banks become increasingly risk averse.

Services have maintained their strong momentum with credit exposure to the sector expanding by 24% by Q2 FY19 as compared to 13.8% recorded in the previous quarter. Offtake to personal loans and overall retail portfolio remained robust leading to historic highs logged in overall credit growth. Gross Bank Credit therefore expanded by 11.3% in September - a full 300 bps higher than what was recorded in March. One disappointment however came in the form declines in credit for consumer durables, which experienced a contraction of (-) 11.6% in March (overall FY18). This can be attributed largely to consumption abeyance due to market volatility and delays in the payment of 7th Pay Commission arrears in some cases.

Stress Assessment of Exposure:In severe stress conditions, 10 PCA banks (+ 3 Non PCA banks) may see their CRAR plummet below the regulatory requirement of 9%.

Taking forward the sector-wise exposure to assess the pockets of stress, the usual suspects continue to haunt the system. Infrastructure, which comprises of 35.5% of the entire exposure records 20.1% of its portfolio as stressed. Food Processing, which comprises of 5.3% of the portfolio records 21.4% of its portfolio as stressed. Basic Metals & Products, with a share of 12.7% had almost 34.2% of the portfolio stressed. It must be noted that most of the sectors that are stressed have large exposures and are critical pillars in the Indian growth story. Speaking of which, there have been certain sectors that deserve a special mention as they saw their portfolios becoming worse-off. These sectors include Infrastructure, Mining, Food Processing and construction; again for reasons pertaining to the overall macros and quantum of exposure.

Considering the stress tests conducting by RBI staff on certain key variables to assess the overall strength/ vulnerability of the system, the following results emerged. As per Baseline estimates, the CRAR of the banking system may come down to 12.9% by Q4 FY19 and further decline to 12.6% by Q2 FY20. This scenario assumes that bank capitalization does not take place as planned and PCA norms remain status quo. Bigger concerns however emerge when factoring in higher stresses.

According to this scenario, if macroeconomic situation ‘deteriorates’ further under Severe Stress Conditions (2 standard deviations away from the mean), the report states then CRAR may come down to 11.5% by Q2 FY20. In such a scenario, the 10 PCA banks (+ 3 Non PCA banks) may see their CRAR plummet below the regulatory requirement of 9%. In case such a hypothetical situation becomes a reality, the Common Equity Tier 1 (CET 1) ratio will go down to 8.9% by Q2 FY20 as compared to the current rate, comprising of a very healthy 10.4%.

Systemic stress was studied through yet another approach under which three different scenarios were ascertained. These scenarios were classified under three heads, Shock 1 (When 1 topmost group borrower fails to meet its obligations), Shock 2 (When 2 topmost group borrowers fail to meet their obligations), Shock 3 (When 3 topmost group borrowers fail to meet their obligations). Under these scenarios, CRAR may come down to 12.5% in Shock 1 and further deteriorate to 11.1% in Shock 3. GNPA will also increase to 15% and 21.1% under Shock 1 and Shock 3, respectively. Capital losses were also evaluated and it was found that nearly 14 banks will be impacted in the worst case scenario spreading the contagion to 23.2% of all SCB assets. The contagion will be contained to less than 11% if just one topmost client defaults in its obligations – a base case situation.

The understanding that one can derive from these numbers is that there exist risks (impediments) and rewards (from proactive policy action) at the same time. Therefore, there are implications of all actions irrespective of their intent. For the uninitiated, the pluses and minus give a mixed bag view of the banking system and models almost all possible scenarios worth considering. Overall, we note that there are system wide stresses that demand immediate remedy but at the same time, we do not discount the efforts of policy makers to alleviate the risks in a highly volatile environment, which bogs the entire eco-system.