Steps taken by the government have averted the piling up of the bad loans, though for the time being only. When the moratorium period ends, we will see the spike in the bad loans. This article explains the same.

Why bad loans are expected to increase

•  Consumer spending has collapsed over the last few months due to the pandemic.
• Though lately there have been some signs of revival, it will take a while before spending comes anywhere near the pre-covid level.
• This will mean that many businesses will start running out of cash pretty soon if they have not already.
• A company that starts running out of cash will not be in a position to repay its loans and, thus, will ultimately default.

How individuals will be affected

• A recent estimate by rating agency Crisil suggests that about 70% of 40,000 companies have cash to cover employee costs for only two quarters.
• This tells us that companies will fire employees, before, during, or even after defaulting on a loan.
• If companies do not resort to employee retrenchment, they will cut salaries and many already have.
• Past payments and future business with vendors and suppliers will be negatively impacted.
• In this situation, the problem at the company level will impact individuals too.
• When individuals start having a cash flow problem, it will lead to defaults on retail loans

But why we are not seeing the defaults happening already?

• A moratorium is a deferment of repayment to provide temporary relief to borrowers. The loan ultimately needs to be repaid.
• The Reserve Bank of India has let banks and non-banking financial companies (NBFCs) offer a moratorium on loans.
• Hence, until the end of August, borrowers have an option to not repay the loans, without it being considered as a default.
• Hence, any loan defaults will start only after August but they won’t be immediately categorized as a non-performing asset or a bad loan.
• Bad loans are largely those loans that have not been repaid for 90 days or more.
•  Hence, defaulted loans will be categorized as bad loans only post-November.
• This will be revealed when banks publish their results for October to December 2020, in January-February 2021.

Conclusion

Even if 20% of loans that end up under a moratorium are defaulted on, the quantum of bad loans, especially those of public sector banks, will go up big time.

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