Non-performing loan ratio of agriculture loan portfolio could double for some banks
Indranil Bhoumik/Mint
The asset quality of India’s agricultural credit could be significantly affected by crop damage due to untimely hail and rain in March, according to India Ratings and Research.
The non-performing loan (NPL) ratio of the agriculture loan portfolio could double for some banks, though the reduction of overall return on average assets (RoA) may be relatively muted at 3-6 basis points (bps; one basis point is one-hundredth of a percentage point). March was the wettest month in India in 48 years. States affected, in varying degrees, include Rajasthan, Madhya Pradesh, Gujarat, Jammu and Kashmir, Uttar Pradesh and Maharashtra, which make up the majority of wheat producing states in the country. Industry experts indicate that wheat output is predicted to fall by 8% due to the rains, which will be the largest decline in production since 2002.
The unseasonal rains immediately followed one of the weakest and most deficient (12%) monsoons that the country had experienced in FY15, which has heightened its effect. The situation may worsen if this year’s monsoon is also below normal. The Indian Meteorological Department estimates a 33% chance of the FY16 monsoon being 90% or below of normal. Banks have recently been extending agricultural loans rather aggressively, on account of the governments’ promotion of agricultural loans, and also given lower credit demand in other sectors. Regional banks with a large rural presence in the affected regions are at a high risk.
Credit growth to agriculture may slow down: Agriculture loans grew 16% year-on-year (y-o-y) in FY15 on account of the governments’ promotion of agricultural loans, and also lower credit demand in other sectors. Bank credit growth for FY15 (12.6% y-o-y growth for total credit) was driven by the agricultural sector, which contributed 25% to the incremental growth in the system between FY14 and first 11 months of FY15.
While the Union budget for FY16 has targeted 6.3% y-o-y growth in banks’ credit to the agriculture sector, actual growth may slow down as banks grapple with continuing deterioration in farm loan asset quality. A final picture will likely emerge in June based on the progress of the monsoon.
If the agriculture lending slows down, banks may have to shift their loanable funds to alternatives such as the Rural Infrastructure Development Fund to meet their priority sector requirements. The switch from the higher yielding agricultural loans to the development fund may affect profitability even further.
Asset quality and profitability impact: We estimate that system-wide agricultural non-performing assets (NPAs) as a percentage of total agricultural advances will rise to 16.9% by the second half FY16 from 13% in FY14 as a direct result of unseasonal rains. Heavily exposed individual banks may also see their agriculture NPA levels growing more than double.
Our estimated profitability impact of these stressed agricultural loans indicate a 2-3 bps system-wide post-tax RoA depletion. A bank-wise analysis indicates the largest profitability impact on RoA at 6 bps. However, most of the affected banks are adequately supported by equity to cover these potential losses.
Stressed assets in Indian banks amounted to 10.6% of total credit at end-December 2014. We had earlier expected this to grow to 13% by end-March 2016. The untimely rains could increase this to 13.4%.
Rating impact unlikely: Affected banks are highly exposed to impacted areas through rural branch presence, and have historically had above-average NPAs stemming from agriculture. These include Bank of Baroda, Bank of Maharashtra, ICICI Bank, Jammu and Kashmir Bank, Oriental Bank of Commerce and Punjab National Bank. Delinquencies on account of affected crops could increase the overall NPL ratio of these banks by 60-100 percentage points. While this will keep credit costs elevated, they have sufficient pre-provision operating buffers to absorb the shock.
Impact to be felt in the second half of FY16: The impact on the system will lag by one or two crop seasons, depending on the crop affected. This is because NPA accounting guidelines by the Reserve Bank of India indicate that a loan to any agricultural plantation will be considered overdue after one crop cycle (for long duration crops) or two crop cycles (for short duration crops), extending bad loan recognition to beyond 90 days past due.
These guidelines, coupled with the fact that banks may choose to restructure these loans may delay recognition further.
Edited excerpts from a report by India Ratings & Research.
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