Covid19 : Is the Banking System going to Support the Economy?

Thanks to the coronavirus lockdown, India is now expected to see its GDP grow by only 2% in the current year. This estimation is by the well-known Fitch Ratings Inc. this would be India’s lowest GDP growth in decades, the kind we have not seen since the dawn of Independence.

We all know that it can be costly to fight the pandemic, and even have an inkling of how long it can take. However, there is much more cause to worry: the sudden and strong pressures on income and demand, for instance. These problems are set to widen the already-wide cracks of the Indian society.

The Weakest Link

It may come as a shock, but the weakest link in our economy is actually the banking sector. Surprise! Who would have thought that the sector that deals with money will be the first to ask for help? However, the truth is that this has been the case for quite some time now. You see, in the recent past the banks lent heavily to the industry when the economy was booming. Then the bad debts started trickling in, after which banks were not eager to lend for new projects. Due to such reasons, banks are in an arming situation right now and need the RBI’s help.

However, even though the times are tough, banks and the entire Indian economy can certainly benefit from a robust household demand. Even while the economy is seen to stall, households continue to buy goods, even if it means getting them on credit. 

Banks have and continue to, cash in on this opportunity. A big part of the banking sector’s optimism lies in the fact that since Mr. Narendra Modi took office, retail loans have only gone up. They have grown beyond 28% of bank lending. In 2019, one of the major credit bureaus reported that unsecured personal loans had the lowest rate of defaults than all other loan categories- just 0.5%! Because of this, retail lending is a safe bet for banks.

Is the Banking Sector Crumbling?

Here’s what happened recently: the Indian shadow banking sector, which had been the chief lender to the underbanked multitudes, suffered from major defaults. They could not continue lending due to their mistrust. This is a problem that is seeping into the mainstream banking sector as well. When Kotak Mahindra Bank gave its realistic view of the possible effect of the coronavirus lockdown on its loans, its investors punished the bank. It seems as though the market is not too fond of realistic views. On the other hand, the HDFC bank was more confident that it won’t be much affected, even if it deals more with unsecured loans.

Banks’ Reactions to RBI’s Covid Regulation

Banks are not happy with the help that is coming from the regulators. They say that nothing substantial has come their way to ease their current problems, especially in the wake of the pandemic lockdown. While the RBI has advised banks to give a 3-month moratorium on loan installments, banks are not really sure how it will help. This is because interest will still add up for borrowers.

The moratorium period offered by RBI has even come under question as of late. Moody's opines that the loan moratorium could cause a greater build-up of credit loss for banks. India and China have both extended such measures to deal with the liquidity crunch amid the COVID-19 crisis. Although this can provide temporary relief to borrowers, it will constrain banks from taking proactive recovery actions and could lead to an even greater build-up of credit loss once the moratoriums are lifted, reports Moody's.

Moody's, in a report on the Asia-Pacific region, said that while policy stimulus will shore up credit quality for larger companies in sectors including airline and oil and gas, Asia's banking sector profitability would decline from falling asset quality and lower net interest margins.

2 Ways in which Banks Could Accentuate the Economic Problem

While in most other countries, banks shall be one of the instruments governments use to fight the virus, it is possible that in India, banks will have a role in actually spreading it instead! Here’s how.

If Indian banks weaken, it will only make the current crisis worse. Firstly, it will complicate the path of economic recovery and growth once the lockdown is over. Bad loans won’t encourage banks to give out new loans once this is over. Besides, their finances will be hard hit.

Secondly, the coming months shall likely become hard for the average Indian. One of the ways in which banks survived the last economic catastrophe from demand collapse was by using the rise of retail loans after Demonetization. Back then, the growth spike was caused by personal loans, home loans and auto loans. This time, it cannot be guessed which one will help the banks.

The Indian government has perhaps waited too long to give relief measures. It may be too late to help banks and the economy now.