Fitch Ratings’ on Monday said its outlook on the Indian banking sector is likely to remain negative until the banks address their weak core capital positions against mounting bad debt and poor financial performance.
The global credit rating agency observed that the capital position of state banks is most at risk, with the core capital ratios of 11 of India's 21 state banks below the 8 per cent common equity Tier 1 (CET1) regulatory minimum that comes into place at financial year-end March 2019 (FYE19).
Banks’ credit costs rose sharply following regulatory changes aimed at accelerating bad-loan recognition and led to losses that cumulatively eroded nearly all of the $13 billion in government capital injected in FY18, adding to capital positions which were already weak.
Loan growth improved to 10.4 per cent in FY18, from 4.4 per cent in FY17. This improvement was shouldered by a few large banks, and sustaining the growth momentum will be difficult without adequate capital replenishment, said the agency.
Fitch said the financials of large private-sector banks weakened further in FY18, but are better than those of their state-owned counterparts, 11 of which are under the central bank's prompt corrective framework.
Non-performing loan ratio
State banks' average non-performing loan (NPL) ratio of 15.6 per cent was more than double that of private banks, which also had a Fitch-estimated average core capital ratio of 13.3 per cent; nearly 500 basis points higher than that of state banks.
"We believe Indian banks will need $40 billion-$55 billion in additional capital to meet Basel III requirements by 2019, with state banks requiring the bulk of this amount.
"Most of the capital is likely to be used for meeting minimum capital requirements and absorbing NPL provisions, around three quarters of which are in the form of CET1," said the agency.
Fitch felt that the State is likely to be forced into providing most of the required capital, since capital raising remain challenging due to state banks' weak equity valuations.
Indian banks' first quarter performance improved slightly on declining credit costs and steady loan growth. However, the $151 billion stock of bad loans remains a risk for the sector's weak income base, which is vulnerable to ageing provisions and slower NPL resolution.
Fitch believes that the sector's legacy problems have been largely recognised, but the system NPL ratio could witness more upside due to residual stress and new risks emerging out of the retail and SME sectors.