Specific numbers are crucial given the wide divergence in stressed asset estimates within each bank category.
Currently, there is a cloud of uncertainty over the Indian banking sector because of non-performing assets (NPAs). Due to this, Indian banks, particularly public sector banks (PSBs), have underperformed the broader market. Investors are worried about the level of bad assets and as happens with the markets often, in the absence of concrete information, it fears the worst. This is coupled with the fact that there have been many sensational reports about the NPA situation, maybe with exaggerated amounts. There are many indebted business groups in India and many reports are trying to classify all the loans to various companies of these groups as suspect. This may not be the best way to estimate the stress in the system.
I must clarify that I do not know the quantum of real bad assets and I suspect neither does anyone else, especially for individual banks. Hence, it may be a good idea for the regulator to try and address this problem of quantification and bring some certainty and rationality to these estimates.
There are concerns surrounding the sanctity of the restructured book and potential problem with stress percolating into various sectors such as iron and steel and infrastructure, led by global factors and slower-than anticipated macro recovery. Furthermore, other new regulatory forbearance such as 5/25 refinancing and strategic debt restructuring (SDR) hasn’t helped either, given there is no or limited disclosure by individual banks. Lack of information has further sown seeds of doubt and uncertainty within the investor community with no clear idea about either the quantum or the cases. This guesswork is proving detrimental for the system as a whole.
Against this backdrop, are we overestimating the problem while constructing worst-case scenarios and hazarding a guess on probability of default? At this juncture, there seems to be an urgent need to build up investor confidence more so given that banks will need to raise capital to be compliant with Basel III requirements for which investors will need a realistic picture. Considering the crucial role of the regulator in addressing concerns and bringing back investor confidence as well as given the widespread belief and trust imposed on them, one idea could be for the Reserve Bank of India (RBI) to conduct stress tests that are used by banking regulators around the world. The stress tests are a systematic and public way to guide banks into shape and can be helpful in bringing stability to lending, which is a cornerstone to economic recovery.
RBI can do something similar to what was being done by the US in 2009, as investors lost confidence in the banks, fearing the worst in the aftermath of the financial crisis. Former Federal Reserve chairman Ben Bernanke wrote in his memoir that the “Fed’s comprehensive stress tests, conducted from February through May of 2009, were a decisive turning point. From then on, the US banking system strengthened steadily”. Recently, the European Central Bank also conducted capital assessments wherein each bank was analyzed across parameters. These parameters included its loans and securities portfolios, as well as any other off-balance sheet commitments and contingent liabilities/exposures. These tests help ascertain potential losses and the capacity of each bank to absorb it along with the additional capital required, which is the capital adequacy ratio (CAR). This is one ratio which gives a complete picture of financial health to the investors. Though it looked like a gamble at that time, in hindsight, the decision to disclose was an important turning point in the financial crisis, bringing back confidence in the financial system. After the stress tests results were announced, slowly, the confidence improved and banks raised capital mainly via the private markets. The stress test is now a regular exercise in the US and the latest test suggesting all 31 banks have passed it indeed instils lot of confidence.
While RBI does a fair bit of stress testing across various categories (such as private, public and foreign banks) and potentially stressed segments (such as iron and steel and infrastructure) in its financial stability report which is published biannually, specific data pertaining to individual banks is not mentioned. This lack of stress test numbers at the individual bank level is creating needless speculation and uncertainty. Specific numbers are crucial in the Indian banking landscape given the wide divergence in stressed asset estimates within each bank category. RBI could look at making available further specifics in terms of various regulatory tools such as SDR and 5/25 refinancing figures for each individual bank as fair disclosures which will help rest the speculation that these might be the postponement of a problem. One may argue that the results may cause concern as some banks may get exposed and eventually have to be capitalized. Conceptually, having one number per bank will give a realistic, complete and transparent picture and will augur well for the system on the whole.
I believe that many banks will see their stock prices go up when the results of these tests are announced. Investors will adjust the stress number and look to the future. A few banks may be exposed as weak but RBI can also insist that these banks raise fresh capital immediately. When a bank raises additional capital, it doesn’t just make its own book stronger; it also makes the entire banking system more stable. This, when seen in conjunction with other prominent steps being undertaken by the government like Indradhanush (aiming to bring more accountability and efficiency), among others, will provide the much-needed boost for the revival of banks. I believe that a quick-footed response by RBI on rising distrust will help revive investor appetite and potentially help banks break through the vicious cycle and emerge stronger.
