Asset deterioration a challenge for banks: Moody’s

The prospects for Indian banks are subdued with asset deterioration being a key challenge over the medium term, according to Moody's Investors Service and its Indian affiliate

"Asset quality will remain a negative driver of the credit profiles of most rated Indian banks and the stock of impaired loans. Non-performing loans (NPLs) and standard restructured loans will still rise during the horizon of our outlook," said Alka Anbarasu, a Moody's Vice President and Senior Analyst.

According to Moody's, such pressure on asset quality largely reflects the system's legacy problems, as relating to the strong credit growth seen in 2009-2012, when the investment plans of Indian corporates rose significantly. Nevertheless, aside from these legacy issues, the underlying asset trend for Indian banks will be stable because of a generally supportive operating environment. While corporate balance sheets stay weak, a further deterioration in key credit metrics such as debt/equity and interest coverage ratios has been arrested.

"We expect the pace of deterioration in asset quality over the next 12-18 months should be lower than what was seen over the last five years, and especially compared to FY2016, even as we consider those remaining problem loans which have not been recognized as such in several large accounts," said Anbarasu.

In this context, Moody's also considers the Reserve Bank of India's (RBI) asset quality review (AQR) in 2015 as a particularly important catalyst in pushing banks to recognize some large accounts as being impaired. As a result, Moody's now estimates that the "true" level of impaired loans for Indian banks to be around 1-1.5 percentage points higher than the latest reported numbers. Given the magnitude of stressed assets in the system,

Moody's expects the banks to increase their focus on resolving some of the large problem accounts. "In this regard, we expect an increased pace of debt restructuring under the various schemes offered by the RBI, including the scheme for the sustainable structuring of stressed assets (S4A), strategic debt restructuring (SDR) and the 5:25 scheme," said Anbarasu.

"Nevertheless, weak reserving levels and continued pressure on profitability will limit the ability of the banks to proactively resolve problem assets under these schemes." From ICRA said a muted level of credit off-take -- on the back of weak demand, increasing competition and greater disintermediation -- will continue to exert downward pressure on lending rates.

"Such a development will be partly offset by the fall in the cost of funds, but stubbornly high operating expense levels and elevated credit costs will continue to dent profitability matrices for the banks," said Karthik Srinivasan, an ICRA Senior Vice President.

"And while bank profitability is not expected to be as weak as the levels seen in FY2016, the weakness in asset quality will continue to drag on profitability indicators, with return on equity remaining in the single digits for FY2017 and FY2018," said Srinivasan.

ICRA further notes that, as of September 30, 2016, while all the public sector banks had met the minimum common equity tier 1 (CET 1) requirement of 6.75% applicable by March 2017, six also reported Tier 1 capital of less than 8.25%, the regulatory minimum. Furthermore, the overall capitalization levels of most of the public sector banks remains moderate to weak, given that they need to attain the regulatory minimum Tier 1 requirement of 9.5% by March 2019.