Arvind Subramanian and Josh Felman argue that there will be a significant deterioration of bank's balance sheet, which would heighten financial sector stress. Around December 2014, there was twin balance sheet challenge: banking sector and infrastructure firms had come under severe financial stress. Now, stressed balance sheets has risen to four: NBFCs and real estate sectors in addition to infrastructure firms and banks. The economic fallout of COVID-19 pandemic has pushed households, firms and financial sector into stress as income and revenue have fallen dipped. A significant increase in NPAs is a very likely scenario.
How bad is the damage likely to be? Reports suggest that around one-third of industrial and service firms have applied for moratoria on their bank loans. If only a quarter of these deferred loans eventually go bad, then the stock of non-performing assets (NPAs) would increase by Rs 5 lakh crore. And this is a conservative estimate. Senior bank officials have been quoted as estimating that the stock of NPAs could increase by as much as Rs 9 lakh crore. In this case, we would be looking at NPAs of Rs 18 lakh crore, equivalent to around 18 per cent of current loans outstanding. For planning purposes, it is worth considering who will pay for such losses, if they do materialise.
Someone will have to pay for the rise in NPAs and to facilitate credit. The government's own fiscal position is stressed with rising fiscal deficit and outstanding public debt. Increasing taxes may not be an ideal policy now.
They suggest acknowledging the stress faced by households, businesses and government in the first place, and take steps to minimize losses by creating a guarantee fund to support lending, and by resolving defaults quickly. The strategy is to sort out bad loans quickly.
They suggest acknowledging the stress faced by households, businesses and government in the first place, and take steps to minimize losses by creating a guarantee fund to support lending, and by resolving defaults quickly. The strategy is to sort out bad loans quickly.
First, by preventing bankruptcies from occurring in the first place. To do this, banks will need to identify the firms that are viable, and lend them the funds they need to tide them over the immediate crisis. But banks are facing their own difficulties, and are reluctant to bear the risk of making such loans. So, the government might need to create a guarantee fund to support lending, as one of us has proposed.
Second, when firms do default, they need to be resolved as quickly as possible. Speed is necessary because the financial position of stressed firms tends to worsen over time. By definition, stressed firms have poor cash flows and can’t obtain much in the way of loans from banks. So, they don’t have enough money to fund their operations properly, which means that over time their underlying business deteriorates, destroying the firms’ market value.
