The operating environment (OE) for Indian banks has strengthened as economic risks associated with the Covid-19 pandemic have ebbed, according to Fitch Ratings.
A number of prudential indicators for the sector have also improved compared with pre-pandemic levels, though growing risk appetite in a relatively benign OE highlights the importance of appropriate buffers against potential stress.
Fitch had revised its OE mid-point score for Indian banks to ‘bb’ from ‘bb+’ in March 2020, after assessing that the pandemic was likely to worsen the existing OE stresses facing the sector.
India was badly affected by the pandemic, but the associated risks have now receded, the agency said.
The credit rating agency observed that India’s OE score continues to benefit from the economy’s well-diversified structure, which helps to reduce banks’ exposure to specific sector-focused shocks.
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The large size of the economy and India’s favourable demographics should offer banks opportunities to generate profitable business and diversify risk and revenue.
Fitch further expects banks to benefit from the gradual formalisation of the SME sector, through initiatives such as the Goods and Services Tax and rapid digitalisation (including of payment systems), which will improve the prospects for providing services at acceptable levels of risk to this substantial part of the market.
Regulatory developments since Fitch’s OE score revision in 2020 have been mixed.
The agency believes that the Reserve Bank of India (RBI) has tightened some norms, building on past measures to strengthen governance, improve board oversight and recognise stress.
For example, regulators revised guidelines for compliance functions in banks in September 2020, and revamped audit rules around rotation of auditors in 2021.
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The RBI also announced plans to implement expected credit loss provisioning for banks in FY24 as part of a shift to align with IFRS9 accounting standards, although implementation of IFRS9 for banks has already been delayed by nearly four years. It was introduced for non-bank finance companies in FY19.
Fitch said the Indian authorities, like many others around the world, introduced wide-ranging forbearance during the pandemic, which obscured banks’ asset quality.
Meanwhile, other structural issues continue to hamper the banking OE. India’s lengthy legal processes remain a major impediment to the implementation of an effective framework for bankruptcy and resolution, and the “bad bank” that was incorporated in July 2021 has not played a meaningful role so far, the agency said.
Referring to Indian banks’ loan growth reaching 15.4 per cent over FY23, the highest since FY13, Fitch believes this partly reflected pent-up credit demand following the pandemic, amid improved capacity for growth, especially among private-sector banks, as well as strong nominal GDP growth. We expect some normalisation in FY24, although credit demand has remained robust in Q1 FY24.
However, rapid loan growth and higher exposure to certain asset classes is also likely to indicate greater risk appetite, amid stiff competition, which could raise sectoral risk if not managed carefully.
India’s private credit/GDP, at around 57 per cent in 2022, is moderately higher than the median for sovereigns in the ‘BBB’ category, of 50 per cent.
India is among fastest-growing sovereigns
Fitch had affirmed the sovereign’s rating at ‘BBB-/Stable’ in May and it currently forecast real GDP growth to average 6.4 per cent annually in the three years to March 2026 (FY23-FY25), putting India among the fastest-growing sovereigns in its rated portfolio.
The credit risk assessor noted that the easing of pandemic-related risks has been accompanied by a strengthening of capital buffers.
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The sector’s average common equity Tier 1 (CET1) capital ratio rose to 13.4 per cent by FY23, from 10.4 per cent in FY18. This partly reflects around $50 billion in cumulative fresh equity provided by the sovereign to state banks since 2015.
According to the agency, earnings buffers appear significant, with operating profits equivalent to around 2.8 per cent of risk-weighted assets by its estimate in FY23, up from 0.6 per cent in FY20.