Indian banks’ NPAs to drop to 3.5%, net interest margin to 2.9% by FY25: S&P Global

  • November 17, 2023
  • Posted by: OptimizeIAS Team
  • Category: DPN Topics
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Indian banks’ NPAs to drop to 3.5%, net interest margin to 2.9% by FY25: S&P Global

Subject: Economy

Section: Monetary policy 

NPA Projections:

  • S&P Global projects Indian banks’ nonperforming assets (NPAs) to drop to 5% by FY 2023–24 and further to 3.5% by FY 2024–25.
  • Anticipates a decline in weak loans to 5% of gross loans by March 31, 2025.
  • Attributes improvement to factors like healthy corporate balance sheets, tighter underwriting standards, and enhanced risk management practices.

Key Factors Impacting Banking Sector:

  • Expects slower global growth and external demand, but believes India’s domestically oriented economy will be less affected.
  • Forecasts credit costs to normalize to 1.2% for the next couple of years.
  • Expects the RBI Governor-led Monetary Policy Committee (MPC) to maintain a pause on interest rates.
  • Does not anticipate a significant rise in interest rates in the near term, limiting risks for the banking industry.

Concerns and Caution:

  • Echoes concerns raised by RBI Governor Shaktikanta Das about the risk of very high growth in personal loans.
  • Flags the rapid growth of unsecured personal loans, cautioning about potential incremental non-performing loans (NPLs).

Loan Growth and Economic Factors:

  • Anticipates loan growth in line with nominal GDP, with retail loan growth exceeding corporate loan growth.
  • Notes that corporate borrowing is gaining momentum, but the uncertain environment may delay capital expenditure-related growth.

Funding Profiles and Return on Assets:

  • Expects banks’ funding profiles to remain sound, supported by a strong deposit franchise.
  • Despite potential challenges, deems the system’s return on average assets adequate.

Challenges for Public Sector Banks:

  • Public sector banks may face challenges due to a relatively high volume of weak assets, leading to higher credit losses.

Mixed Outlook for Finance Companies:

  • Foresees a mixed performance for finance companies (fincos), with weaker asset quality compared to major private sector banks.

The S&P Global report provides insights into the outlook for India’s banking sector, emphasizing improvements and potential challenges in the coming years.

About Net Interest Margin (NIM)

Net Interest Margin (NIM) is a key financial metric used in the banking industry to measure the profitability of a bank’s core lending and investment activities.

It represents the difference between the interest income earned by a bank and the interest expenses it incurs relative to its interest-earning assets.

  1. Net Interest Income (NII):
    • Net Interest Income is the difference between a bank’s interest income and its interest expenses. It is a measure of how much money a bank earns from its core lending and investment activities after accounting for the cost of funds.
  2. Average Earning Assets:
    • Average Earning Assets represent the average value of a bank’s interest-earning assets over a specific period. These assets include loans, securities, and other investments that generate interest income for the bank.
  3. Calculation Basis:
    • The numerator (Net Interest Income) represents the earnings from interest-related activities, while the denominator (Average Earning Assets) adjusts this income for the average level of interest-earning assets deployed by the bank. The resulting ratio is expressed as a percentage.
  4. Significance:
    • NIM is a critical metric for assessing a bank’s ability to generate profits from its core banking operations. A higher NIM indicates that a bank is earning more from its interest-related activities relative to the size of its earning assets.
  5. Margin Spread:
    • NIM is often referred to as the “margin spread” or simply the “margin” because it measures the spread or difference between the interest income and interest expenses.
  6. Factors Influencing NIM:
    • NIM can be influenced by various factors, including interest rates, the bank’s lending and investment strategies, the cost of funds, and the economic environment. Changes in interest rates, for example, can impact the profitability of a bank’s interest-related activities.
  7. Industry Benchmark:
    • NIM is closely monitored by investors, analysts, and regulators as an indicator of a bank’s financial health and efficiency. It is often compared to industry benchmarks and used in financial analysis to evaluate a bank’s performance relative to its peers.

Understanding Non-Performing Assets (NPAs):

  1. Definition:
    • NPAs are assets of a bank that are not generating income.
    • Specifically, loans or leases failing to meet stated principal and interest payments.
  2. Risk to Banks:
    • Loans on a bank’s balance sheet are listed as assets.
    • Non-payment by customers poses the risk of declining asset values.
  3. Criteria for Classification:
    • Loans have a grace period before being marked overdue.
    • NPAs typically include commercial loans over 90 days overdue and consumer loans over 180 days overdue.
    • Agricultural loans are classified as NPAs if interest/principal remains overdue for two harvest seasons.
  4. Categories of NPAs:
    • Sub-standard (aged <= 12 months).
    • Doubtful (aged > 12 months).
    • Loss assets (identified as loss but not written off).

Prevention and Solutions:

  1. Legal Mechanisms:
    • Utilize Acts like SARFAESI Act (2002) and Recovery of Debts Due to Banks and Financial Institutions Act (1993) for legal recovery.
    • Debt Recovery Tribunals (DRTs) and Lok Adalats expedite recovery through legal means.

National Asset Reconstruction Company Ltd. (NARCL):

  1. Introduction:
    • NARCL, established to address bad loans, will acquire the first set of NPAs exceeding ₹500 crore from banks.
    • Proposed in the Budget for 2021-22, it aims to create a bad bank structure housing an Asset Reconstruction Company (ARC) and an Asset Management Company (AMC).
  2. Ownership and Collaboration:
    • Collaboration between public and private sector banks.
    • Majority ownership by state-owned banks.
    • Assistance from India Debt Resolution Company Ltd (IDRCL), primarily owned by private banks, in the resolution process.
  3. Differentiation from Existing ARCs:
    • Public sector character with government backing.
    • Capacity to purchase significant accounts, freeing banks from holding these on their books.
  4. Asset Reconstruction Company (ARC):
    • Specialized financial institution acquiring NPAs from banks for balance sheet cleanup.
    • Registered under RBI.
    • Legal basis provided by the SARFAESI Act, 2002.
  5. Legal Basis (SARFAESI Act, 2002):
    • SARFAESI Act enables the establishment of ARCs in India.
  6. Capital Requirements for ARCs:
    • Amendment in 2016 set a minimum net-owned fund of Rs. 2 crores.
    • Subsequent increase to Rs. 100 crores in 2017.
    • Capital adequacy ratio requirement of 15% of risk-weighted assets.
  7. Need for Bad Bank Model:
    • Addressing total stress in the banking system exceeding Rs 15 lakh crore.
    • Banks, strained with stressed assets and limited capital, face challenges in managing NPAs.
    • The bad bank model aims to assist both the government and banks in dealing with the NPA burden.

Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002:

  1. Purpose:
    • Allows banks and financial institutions to auction properties (residential and commercial) when borrowers default on loan repayments.
  2. Objective:
    • Aims to empower banks to take measures for the recovery or reconstruction of loans, reducing non-performing assets (NPAs).
  3. Applicability:
    • Effective primarily against secured loans where banks can enforce the security held against the loan.

Asset Reconstruction Companies (ARCs) and Securitization Companies (SCs):

  • Promotes the establishment of ARCs and SCs to handle the NPAs accumulated by banks and financial institutions.
  • These specialized entities play a crucial role in acquiring and managing distressed assets, contributing to the cleanup of banks’ balance sheets.

Legal Foundation:

  • SARFAESI Act, enacted in 2002, provides the legal basis for these measures to strengthen the financial system and address the issue of bad loans

About S&P Global Inc.:

  1. Nature of Business:
    • S&P Global Inc. is an American publicly traded corporation.
  2. Headquarters:
    • The company is headquartered in Manhattan, New York City.
  3. Primary Business Areas:
    • S&P Global Inc. primarily operates in the fields of financial information and analytics.
economy Indian banks’ NPAs to drop to 3.5%