Higher interest rates could make it harder for banks to raise capital: Fitch

Fitch Ratings expects policy interest rates in India to rise further, reaching 5.90 per cent by end-2022, which could affect securities valuations, making it harder for banks, particularly state-owned banks, to raise fresh capital.

Further, mounting repayment pressure for some borrowers amid the interest rate hikes, particularly for micro, small and medium enterprises (MSME), will test banks’ loan underwriting quality. However, asset-quality risks from higher rates should generally be moderate for most banks.

The rating agency, in a note, cautioned: “Higher rates will also affect securities valuations and could make it harder for banks to raise fresh capital, particularly at state banks, although wider net interest margins (NIM) will have offsetting positive credit effects.”

The Reserve Bank of India (RBI) raised policy interest rates by 50 basis points to 4.90 per cent in June from 4.40 per cent. Fitch expects rates to rise further, reaching 5.90 per cent by end-2022 and 6.15 per cent by end-2023, then remaining at this level through 2024.

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‘State banks will lose market share’

The agency underscored that higher interest rates could make raising additional private capital more challenging, making state banks more reliant on equity injections from the government if they are to maintain market share.

Fitch expects banks’ capital buffers to remain commensurate with current ratings in the near term, although weaker capitalisation will be a greater constraint on loan growth at state banks than at private-sector rivals.

“We believe state banks will lose market share in the next two to three years due to an inability to raise sufficient capital to match the level of loan growth at private banks. However, this is unlikely to affect bank ratings as the process will be gradual and we expect large state banks to remain among the largest in India’s banking system over the medium term,” said Saswata Guha, Senior Director; and Prakash Pandey, Associate Director, Fitch Ratings.

Quick in hiking lending rates

The agency noted that banks have been quick to pass on higher rates through loan portfolios, which are mainly floating in nature, but have been slower in raising deposit rates. This trend should support higher net interest margin (NIM), but the lack of competition for deposits may point to relatively muted demand for new credit, it added.

“Generally, asset-quality risks from the rate hikes should be manageable for most banks. Aggregate corporate leverage has fallen back in recent years and India has a low level of household debt/nominal GDP at 14.5 per cent in 2021. Nonetheless, some areas could experience heightened credit stress,” as per the note.

The RBI’s June 2022 Financial Stability Report noted that the sector has begun to show signs of revival while highlighting that risks still persist.

Higher interest rates: a challenge for MSMEs

“We expect higher rates to pose particular challenges for this sector, and believe that any consequent rise in bank credit costs from asset-quality deterioration could be amplified by the unwinding of regulatory forbearance on Covid-19 affected loans. The unwinding is likely to start from the financial year ending March 2023, assuming authorities do not extend forbearance further,” Fitch observed.

It added that Indian banks rated by it have relatively large securities portfolios compared with other Asian banking markets, and higher bond yields will cause banks to recognise fair value losses in available-for-sale (AFS) portfolios.

“However, it is possible that the RBI could reintroduce mechanisms it has used in the past to cushion the impact of rising yields on balance sheet valuations, such as the reclassification of some AFS securities to held-to-maturity or allowing mark-to-market value changes to be spread out over several quarters,” the agency said.