Gross non-performing assets (GNPAs) of banks — a key indicator of asset quality — is expected to improve 90 basis points (bps) to ~5% this fiscal on-year, and another 100 bps to a decadal low of ~4% by March 31, 2024 (see chart in annexure), riding on post-pandemic economic recovery and higher credit growth.

The asset quality of the banking sector will also benefit from the proposed sale of NPAs to the National Asset Reconstruction Company Ltd (NARCL).

That said, not all segments will perform equally well. The biggest improvement will be in the corporate segment, where gross NPAs is seen falling below 2% next fiscal from a peak of ~16% as on March 31, 2018.

Says Krishnan Sitaraman, Senior Director and Deputy Chief Ratings Officer, Crisil Ratings, “The steady improvement in corporate asset quality is clearly reflected in leading indicators such as the credit quality of bank exposures. A Crisil Ratings study of large exposures of banks, constituting more than half of corporate advances, shows the share of high-safety¹ exposures has increased to 77% as on March 2022 from 59% in March 2017, while exposure to sub-investment grade companies more than halved to 7% versus 17%.”

This asset quality improvement in the corporate segment follows a significant clean-up done of bank books in recent years, and strengthened risk management and underwriting. This has also led to increased preference for borrowers with better credit profiles.

The deleveraging and strengthening of India Inc balance sheets also helped. This is reflected in the Crisil Ratings credit ratio (upgrades to downgrades), which touched 5.04 in the second half of last fiscal. The trend of upgrades comfortably outnumbering downgrades should continue over the medium term.

With much of the stress in the corporate loan book already recognised and better quality of incremental lending, restructuring for this segment was low at ~1%, covering only a few corporate groups. Mechanisms such as the Insolvency and Bankruptcy Code have also supported recoveries and increased credit discipline among borrowers.

Gross NPA in the MSME² segment, which suffered the most during the pandemic, may rise to ~10-11% by March 2024 from ~9.3% as on March 31, 2022. While relief measures did help contain asset quality deterioration last fiscal, the segment saw the most restructuring at ~6% compared with ~2% for the overall banking sector. About a fourth of these accounts could potentially slip into NPAs.

The retail segment remains resilient and gross NPAs are expected to remain rangebound at 1.8-2.0% over the medium term. While the impact of increase in interest rates and inflationary pressure on individual borrowers’ cash flows will need to be monitored, almost half of the retail loans are home loans, where borrowers have relatively better credit profiles. While segments such as unsecured loans may see some pressure, overall retail asset quality is expected to stay within expected bounds.

Agriculture segment gross NPAs is seen flat at 9-10% following another year of reasonably normal monsoon and harvest.

Says Subha Sri Narayanan, Director, Crisil Ratings, “We expect slippages to trend 50 bps lower at ~2.0% for fiscal 2024 versus 2.5% last fiscal as the economy stabilises. This should support asset quality metrics even as the pace of write-offs, which contributed almost 60% to the reduction in gross NPAs in the past three fiscals, and large-ticket resolutions decelerate. Our base-case estimate factors in part-sale of legacy corporate loan NPAs to the NARCL, which should snip reported gross NPAs by ~50 bps.”

Over the medium term, to avoid a repeat of past asset-quality challenges, it is important that banks don’t relax their credit underwriting standards while focussing on faster growth.

¹ Includes AAA/AA category and exposure to public sector undertakings
² Micro, small and medium enterprises