Keeping in thoughts the damaging consequences of prolonged regulatory forbearance following the 2008 worldwide economic crisis (GFC), policymakers ought to lay out thresholds of financial recovery for withdrawal of the present regulatory forbearance on bank loans, economists in the finance ministry stated.
“Remember that forbearance represents emergency medicine that should be discontinued at the first opportunity when the economy exhibits recovery, not a staple diet that gets continued for years,” the economists stated in the Economic Survey 2020-21. An Asset Quality Review (AQR) workout have to be performed right away right after the forbearance is withdrawn and the legal infrastructure for the recovery of loans requires to be strengthened de facto, they added.
The present regulatory forbearance on bank loans has been necessitated by the Covid-19 pandemic. Regulatory forbearance for banks involved relaxing the norms for restructuring assets, exactly where restructured assets have been no longer expected to be classified as non-performing assets (NPAs) and hence did not call for the levels of provisioning that NPAs attract.
During the GFC, forbearance helped borrowers tide more than short-term hardship triggered due to the crisis and helped stop a substantial contagion. However, the forbearance continued for seven years, although it ought to have been discontinued in 2011, when GDP, exports, IIP and credit development had all recovered considerably. Given relaxed provisioning specifications, banks exploited the forbearance window to restructure loans even for unviable entities, thereby window dressing their books. The inflated income have been then applied by banks to spend elevated dividends to shareholders. As a outcome, banks became severely below-capitalised.
Concerned that the actual circumstance may perhaps be worse than reflected on the banks’ books, RBI initiated an AQR to clean up bank balance sheets.
While gross NPAs elevated from 4.3% in 2014-15 to 7.5% in 2015-16 and peaked at 11.2% in 2017-18, the AQR could not bring out all the hidden poor assets in the bank books. This led to a second round of lending distortions, thereby exacerbating an currently grave circumstance.
The prolonged forbearance policies following the GFC hence engendered the current banking crisis that brought down investment prices and thereby financial development in the nation, the Survey noted.