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Indian banking sector is at a crossroad. And as crossroads are always fraught with the risk of a misjudgement of the oncoming traffic, it needs to be careful.

Lets walk a year back and revisit the start of pandemic closure in March 2020. As the country went for a total lockdown on the fourth week of March, on March 27 RBI had come up with the Covid 19 Regulatory Package which permitted for a moratorium on instalment payments falling due between March 1, 2020 and May 31, 2020, on term loans, agricultural term loans, retail loans including home and personal loans. The repayment schedule for such loans as also the residual tenor, will be shifted across the board by three months after the moratorium period. Interest shall continue to accrue on the outstanding portion of the term loans during the moratorium period.

 In respect of working capital facilities sanctioned in the form of cash credit/overdraft (“CC/OD”), lending institutions were permitted to defer the recovery of interest for the same period. The accumulated accrued interest shall be recovered immediately after the completion of this period.

Both of these measures were extended by another three months to August 31st later in May ’20.

As an enabling measure, the asset classification of term loans which are granted relief shall be determined on the basis of revised due dates and the revised repayment schedule. Similarly, working capital facilities where relief is provided the Special Mention Account (SMA) and the out of order status shall be evaluated considering the application of accumulated interest immediately after the completion of the deferment period as well as the revised terms.

Next few months, the banking industry in India, like its counterpart around the globe, faced an unprecedented challenge to stay afloat as it struggled hard to restore credit flow while bracing up the large scale delinquencies and balance sheet stress. Thanks to the policy ease, prodded by the Supreme Court stay order, the RBI offered, which stopped banks from classifying bad loans as bad as of August 31, 2020.

An estimate by rating agency ICRA, pegged the accumulated bad loans in the bank coffer to be appx `1.3 trillion between September and December 2020, which is not yet reflected in the bad loan figures. Compared to March 2018, when it touched about `10.36 trillion the December 2020 figure of bad loan was already hovering around `7.57 trillion. So the ICRA estimate of bad loan, if added up, the figure jumps to `8.87 trillion. Banks will start declaring the fresh bad loans while publishing the Q4 and FY 20-21 results in coming few weeks, which is expected to throw up surprises.

Another chainmail from RBI was MPC’s accommodative stance in the monetary policy beginning October 2019 – March 2020 half year. In its October 2019 meeting, the MPC had noted that the continuing slowdown warranted intensified efforts to restore the growth momentum. With inflation expected to remain below target in the remaining period of 2019-20 and Q1:2020-21, the MPC took the view that policy space could be used to address growth concerns within the flexible inflation targeting mandate. Accordingly, it voted to reduce the policy repo rate by 25 basis points (bps) to 5.15 per cent. In its off-cycle meeting in March ‘20, the MPC noted that macroeconomic risks brought on by the pandemic could be severe, both on the demand and supply sides, and stressed upon the need to do whatever is necessary to shield the domestic economy from the pandemic. The MPC further reduced the policy repo rate by 75 bps to 4.4%. In its April-September 2020 policy again the MPC took a lenient view as “various sectors of the economy were experiencing more acute stress than initially anticipated and financial conditions needed further easing to prevent the deep distress in the economy”; it further cut the repo rate by 40 basis points (bps) to 4.0%.

During October 2020-March 2021, the MPC noted that the revival of the economy from the unprecedented COVID-19 pandemic assumed the highest priority and in February 2021 decided to maintain status quo on the policy rate and continue with the accommodative stance set out in the October resolution. RBI also tried to push in liquidity in the market by purchase of government securities through open market operations (OMO). With the Economy slowly opening up and economic activity re starting it seemed like the worse was behind us.

If Dalal Street price movement is any indicator, then the bank bell weather NSE Bank Nifty moved higher by about 74% in the FY 20-21. Out of 249 trading sessions, on 105 it fell average 410 points and on residual 143 occasions it closed higher at an average of 512.

But the second wave of pandemic looks like a spoil sport. While it is prowling with renewed rage, the symptoms of tremor and the fear factor of 2020 are making a breakthrough. The excess liquidity in the banking system had stood at `3.8 trillion on March 31st. It has since grown `5.5 trillion around 3rd week of April which is an indication of slow lending. The second round of reverse migration of workers from states like Maharastra , Gujarat, UP has already started, which means production capacity across industry is being slashed. Health infrastructure around the country is everyday getting challenged by the mighty contagion. All these show that the negative impact of the second wave is already here!

A ballpark estimate shows that more than 80% of the new infections are in the prominent states which account for roughly 45% of the banking sector credit. This is surely going to be a dampener for the banks’ recovery. Another hit the bankers anticipate is that of the compensatory outgo based on a SC order, of about `7000 crore payable to the borrowers having loan above `2 crore, towards difference of compound and simple interest. Unlike previous occasion, when Central Government agreed to bear the amount payable to the borrowers having loan up to `2 crore, this needs to be defrayed by the respective lender.

The optimism that was in existence couple of months ago gradually transforming into that of an uncertainty. RBI, in an allusion to the infection curve, said "since mid-September, India has ‘bent it like Beckham’" — but the current scenario looks far more twisted and banking is likely to be a fragile lot in days to come.

- The author works for Peerless Financial Services Ltd. in Legal & Risk Management.