COVID Challenge: How Should The Banks Respond?

The recent global turmoil caused by COVID-19, a virus hitherto unknown, has caused enough disruptions sparing neither developed nor developing countries and has already taken thousands of lives. The impact, both socially and economically, is perhaps the biggest since World War II. The cross-border movement of people has practically stopped, trade has come to a standstill, production processes have been clogged and the entire supply chain has been derailed. Measures to ensure social distancing by enforcing lockdowns, shutdowns, quarantine etc by sovereign governments have created an environment of anxiety and uncertainty. No one really knows what lay ahead.

How the financial system, particularly the banking system, will be impacted is anyone’s guess, but there is unanimity of opinion that the roads are going to be bumpy. When the real economy takes a hit as is happening now, its effects are generally felt across countries, segments and sectors, bringing into focus the downside risks of present-day globally interconnectedness. In such a scenario, it becomes virtually impossible for the financial sector to remain immune. It is but natural that banks will find it difficult to escape the mayhem now and also in the post- COVID-19 world.

In the context of India, at the ground level economic activity has come to a virtual standstill, affecting cash flows of every enterprise whether it is retail or big business in a non-discriminatory manner. When Ramsharan, a small farmer, looked at his standing vegetable crop a few days back, the fully ripe red tomatoes he had dreamt of were hanging. Almost 5 quintals at a reasonable rate meant a fortune for him. But now there is no one to pluck it, no transport to ferry it to the nearest mandi and going by his friends the mandi remains closed. His dreams lay shattered. The only comfort he gets is by cursing his luck. The story of Ramsharan is not an aberration; rather the likes of him are dotted across rural India. What does the future hold for them? How long will this huge disruption last? Nobody would like to hazard a guess as the likes of Ramsharan are too many.
It is clear that enterprises will find it hard to come out of their present situation in a hurry. Logistics involved in the supply chain will have to be re-established and this may pose a big challenge. The availability of labour will become extremely critical for many days or weeks to come. The time involved in rebooting will not be the same for everyone; the longer it takes the bleaker will be its chances of remaining on track.

This is bound to adversely affect the repayment schedule, leading to liquidity issues for lenders which in turn will affect further lending. The identification of NPAs in the aftermath of Asset Quality Review by RBI had created enough dents in the balance sheets of banks. Slowdown of the economy, even before the COVID-19 pandemic, had its own impact on the bank’s balance sheets. Implementation of the Insolvency and Bankruptcy Code, setting up of NCLT and a slew of other measures during the last few quarters or so, slowly yet steadily, had made the banks look somewhat better. Recapitalisation by the government, strong and determined efforts towards recovery of dues etc. gave some headroom to banks for further lending. Consolidation of the banking sector through merger of some PSBs, perhaps, would have also contributed to efficient reallocation of scarce capital in the near future. The onset of COVID-19 seems to have pushed those gains back by several notches. The possibility of largescale NPAs clearly stares at them and banks will have to perhaps restart from here.

The impact is already visible everywhere. The strong business entities are likely to limp back on the strength of their built-in reserves. Many of them will re-open and re-organise and possibly manage to survive with soft rescheduling of debt. The small ones, which have either borrowed directly from banks or from NBFCs or MFIs, will find it extremely difficult to service the debt. Many of them may simply perish. The MSME sector will be worst hit because except a few concessions here and there they will neither get a complete waiver or a soft deal from the lenders.

A crucial function at this stage will revolve around the policies of Union Government and RBI. The government has already announced various stimulants. RBI has also come out with a scheme of moratoriums and liquidity support. More may come if need be. But the moot question will be for how long and to what extent these incentives can be sustained and whether they will take care of the interest of the banking industry or for that matter the depositors’ interests. The answer is certainly not easy.

Banks in India will be called upon or even pushed to support the revival plans whether they like it or not. Many may not dispute this approach too in the present context. Unusual times, obviously, calls for unusual policy responses. Reduced interest rates on lending, concessional and deferred credit facilities will be the demand from the Industry. At this juncture, managing various financial parameters/ ratios to assess their financial health, particularly the Net Interest Margin (NIM), to remain afloat will be a Herculean task for the top management of banks. They have to indulge in a very challenging balancing act. In order to reduce their lending rates as a policy response to any reduction in policy rates, the banks have already started to reduce the rate of interest on their liability side. Any reduction in Savings Bank Accounts/FDs is always a big blow to small depositors/ pensioners. Yet, banks have been going ahead. Small depositors are more likely to follow the safety first principle and lack of other risk-free investment options will force them to continue with banks with a lower return. Though miniscule, this may surely have an indirect impact on the consumption level by way of reduced consumptions. Another dimension will be deployment of deposits by the banks in the form of credit expansion. Whether such opportunities will come or not is doubtful since overall there is a subdued sentiment for capital investment.

The banking industry in India in the last three decades saw drastic changes. Trying to align itself with global standards, it has adopted several international norms on Capital Adequacy, Risk Management, Regulation and Supervision, Payments System and so on, driven strongly through regulatory prescriptions. The list is illustrative not exhaustive. The economy also took to the fast lane; global funds came in making them an important player in the Indian Financial Market. Reforms were carefully and diligently customised by taking the domestic socio-economic, cultural and, more significantly, political factors into consideration. Reforms continue to top the agenda and it is still a work in progress. Indian economy grew and the growth story is quite impressive, notwithstanding the slowdown in the last few quarters.

This process of global integration always carried the risk of global shocks; be it small or big or be it social, economic or political phenomenon. Indian banks have shown the desired level of resilience which is visible from the way it remained immune to the contagion effect in 2008 which shook the world economy. Things have moved on since then and how the prevailing risk management systems of banks in India cope with the impact of COVID-19 remains to be seen.

Though unforeseen, timing of the outbreak has added to the immediate woes of the banking industry as merger of 10 nationalised banks has just been implemented to bring down the number to four. A large private sector bank was put under moratorium recently, raising public concern about credibility of private players. Liquidity constraints faced by the NBFC sector against the backdrop of failure of a couple of leading companies in the recent past have raised issues of governance.
Banks in India have on hand multiple issues to tackle.There will be multidirectional pulls and pushes. In a system where the state plays a significant role in banking affairs, banks are more likely to act in sync with state-mandated objectives while simultaneously addressing its other business-driven issues. This is both a boon as well as a bane and will call for a fine-balancing act. Challenges always throw opportunities and first things first. Banks in India will do well to address the immediate short-term concerns to ensure the economy comes back to near normal, if not normal, before looking at their balance sheet concerns.

(The author is a former Chief General Manager, RBI)