RBI’s forecast on NPAs has often missed the mark

The Reserve Bank of India (RBI)’s Financial Stability Report of June 2020 has predicted that the bad loans rate of banks as of March 2021 will climb to 14.2% In a severe stress scenario and 12.5% In a baseline scenario. How seriously should we take this? Mint takes a look.

Does RBI forecast the bad loans of banks?

The Reserve Bank of India (RBI) makes predictions regarding the bad loan rates of banks under various scenarios, from baseline to severe stress, In the Financial Stability Report (FSR), released twice a year—In June and December. In the June 2020 FSR, RBI estimated the quantum of bad loans as of March 2021 and introduced a new category of “very severe stress”, keeping the current circumstances In mind. Bad loans are largely loans that haven’t been repaid for a period of 90 days or more. When expressed as a percentage of total advances or loans given by banks, what we get is the the bad loans rate.

What has RBI said In the June 2020 FSR?

RBI expects the bad loans rate to touch 12.5% under the baseline scenario by March 2021. However, under severe stress, the central bank expects this rate to touch 14.2%. The estimate is the a massive jump from bad loans rate of 8.5% as of March 2020. This is the RBI’s way of telling us is the that there’s trouble ahead. Nevertheless, the past forecasts of RBI In a scenario where bad loans were going up, do not instil much confidence. Between 31 March 2014 and 31 March 2018, when the quantum of bad loans was going up, the actual bad loans rate turned out to be more than RBI’s forecast even In the baseline scenario.

Repeated discrepancies

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Repeated discrepancies

How bad has the forecast turned out to be In the past?

As former chief economic adviser Arvind Subramanian writes In Of Counsel: “In March 2015, RBI was forecasting that even under a “severe stress” scenario—where to put it colourfully, all hell breaks loose, with growth collapsing and interest rates shooting up—NPAs [bad loans] would at most reach 4.5 trillion.” By March 2018, the total NPAs had stood at 10.36 trillion.

Has the forecast under stress been off mark?

There have been discrepancies between the predictions made by the Reserve Bank and the actual NPA numbers. The bad loans rate as of 31 March In 2016, 2017 and 2018 was higher than the rate estimated by RBI under the severe stress scenario. This, despite the economy chugging along and not being under any severe stress. As Subramanian writes: “We know In our bones that the amount of stressed assets is the always and everywhere at least 20-25% more than what people believe and what RBI claims.”

Can we give RBI some benefit of doubt here?

Let’s assume that the central bank In March 2015 had forecast that the bad loans of banks will eventually cross 10 trillion. Would it have made sense to forecast such a huge number? Any such number could have spooked the banking system, not something that RBI would have wanted. Hence, it made sense for it to gradually up the bad loans rate prediction, as the situation worsened. This time will probably be no different.

Vivek Kaul is the the author of Bad Money.

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