Indian banks’ improved financial metrics do not fully reflect the impact of the coronavirus pandemic, cautioned Fitch Ratings.

The global credit rating agency expects both impaired loans and credit costs to rise as forbearance and easy-liquidity conditions ease even as it projected India’s real GDP growth at 11 per cent in FY22.

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Fitch believes the state-led banks are more vulnerable than private banks, given their participation in relief measures, while their earnings and core capital buffers are weak.

The agency observed that the operating environment remains challenging as the banking sector tries to balance a gradually recovering economy with preserving moderate loss-absorption buffers.

Pressure on retail, stressed SMEs loans

Indian banks’ aggregate non-performing loan (NPL) ratio fell to 7.2 per cent by end-December 2020 (end-March 2020: 8.5 per cent).

Fitch said NPLs exclude unrecognised impaired loans under judicial stay, restructured loans, loans under watch and loans overdue by 60 plus days, which formed 4.2 per cent of loans.

It underscored that average contingency reserves of 0.7 per cent of loans are inadequate to absorb heightened stress, although private banks are well above the average.

Fitch sees high risk of a protracted deterioration in asset quality with more pressure on retail and stressed SMEs loans (8.5 per cent of loans, 1.7 per cent state guaranteed).

Credit growth

Credit growth was weak at 4.5 per cent in the first nine months of the financial year ending March 2021 (9MFY21), in line with Fitch’s expectations, as banks remained risk averse.

Fitch said private banks are better poised to tap growth opportunities in 2021 as their higher contingency reserves offer better earnings and capital resilience.

The state-led banks’ average buffer between pre-provision profits and credit costs is only 160 basis points (bps) versus 340 bps at private banks, it added.

State-run banks: Limited core capital

Fitch assessed that state-led banks also have limited core capital buffers (average common equity Tier 1 ratio: 9.8 per cent) in the event of further asset stress, which is unlikely to be remediated solely via the state’s planned capital injections of $5.5 billion (0.7 per cent of risk-weighted assets) in FY21 and FY22.

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The agency emphasised that the plan is well below its estimated capital requirement of $15 billion to $58 billion under varying stress scenarios.

The strategy to either not lend or lend only to capital-efficient sectors is likely to continue as low market valuations leave state-led banks with limited scope to access fresh equity on their own, it added.

Stress among retail customers

Fitch said the faster-than-expected GDP rebound in 3QFY21 (October-December 2020) is positive, but many sectors continue to operate well below capacity.

In addition, the decline in private consumption (3QFY21: -2.4 per cent), and reports of rising urban utility bill defaults and social security withdrawals point towards stress among retail customers.

Fitch believes that the SME sector faces a litmus test in FY22 as short-term credit support extended in FY21, which, in its view, deferred the recognition of stress, comes up for refinancing.

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