India's central bank warned that an expected doubling of bad loans and soaring financial markets in the nation's weakened economy threaten financial stability.
The non-performing asset ratio is forecast to rise to 13.5% by the end of September from 7.5% a year ago, the Reserve Bank of India said in its semiannual Financial Stability Report published Monday. If the number holds through the fiscal year ending March 2022, it would be the worst since 1999.
"Domestically, corporate funding has been cushioned by policy measures and the loan moratorium announced in the face of the pandemic, but stresses would be visible with a lag," the Reserve Bank said. "This has implications for the banking sector as corporate and banking sector vulnerabilities are interlinked."
Like their global peers, Indian lenders have been hit hard by the coronavirus outbreak, which triggered an unprecedented economic slump hurting borrowers' ability to repay debts. Banks came into the year already weakened by a two-year-old shadow lending crisis and are now struggling with one of the worst bad-loan ratios among major nations.
In response, the RBI has taken unprecedented steps to help lenders, including a loan repayment moratorium that ended in August, followed by a two-year debt restructuring program. The measures have made it harder to assess the extent of the bad-debt issue.
"Congenial liquidity and financing conditions have shored up the financial parameters of banks, but it is recognised that the available accounting numbers obscure a true recognition of stress," Governor Shaktikanta Das wrote in the report. "It is in this context that banks must exploit the congenial financial conditions and the conducive policy environment to plan for capital augmentation and alterations in business models that address emerging challenges."
The RBI expects banks' capital ratios will erode to 14% in September from 15.6% in September 2020, the report showed. This may worsen to 12.5% in a very severe stress scenario, under which nine banks may fall short of meeting the minimum capital requirement of 9%.
Most banks raised capital in the past six months. Private lenders led the pack, followed by state-run peers, including the country's largest lender State Bank of India, which raised funds via additional Tier 1 bonds.
Mr Das also cautioned about a widening "disconnect" between "certain sections of the financial markets and the real economy." India's benchmark stock index has followed its global peers in surging to fresh record highs while the government estimates gross domestic product will fall 7.7% in the year through March 2021, the biggest contraction since 1952.
"Stretched valuations of financial assets pose risks to financial stability," Mr Das said. "Banks and financial intermediaries need to be cognizant of these risks and spillovers in an interconnected financial system."