The bad loans of Indian banks are likely to peak after financial year 2022-23 as the regulatory relief measures amidst the COVID-19 pandemic have postponed underlying asset quality issues for now, Fitch Ratings said.
Saying the bad loans ratio of Indian banks at 7.5 per cent in FY21 was moderately better than its expectations, Fitch said it was supported by declining fresh bad loans as well as high levels of write-offs.
"Continued relief measures aimed at COVID-19 affected segments (such as micro, small and medium enterprises (MSME), retail and contact services) played a crucial role in deferring recognition of problems with asset quality," the rating agency said in a report titled "Indian Banks 2021 Report Card".
The considerably-better performance of private banks than state banks has positively influenced banking system aggregates in addition to deferred recognition of stressed assets that has masked the stress. The improved performance of banks in FY21 is in contrast to the stress evident from the extension of COVID-19 related relief measures to borrowers, it said.
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Finance Minister Nirmala Sitharaman had on June 28 announced a Rs 6.29-lakh crore stimulus package to revive the economy hit by the second wave of COVID-19 pandemic, including an additional Rs 1.5 lakh crore for credit guarantee scheme.
Fitch has already revised down India's real GDP growth projection for FY22 by 280 basis points to 10 per cent. The rating agency said rapid vaccination can support a sustainable revival in business and consumer confidence, however, without it, economic recovery would remain vulnerable to further waves and lockdowns.
The challenges faced by Indian banks have increased due to the second wave of pandemic. The renewed restrictions to control the surge in new COVID-19 cases have slowed recovery efforts and left banks with a moderately worse outlook for business and revenue generation in FY22, Fitch said.
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"The operating environment remains challenging for the banks with limited opportunities for business and revenue growth. Problems could escalate in the event that successive COVID-19 waves and lockdowns prevent a meaningful economic recovery considering that India's full vaccination rate is still quite low," it said.
Fitch expects banks to manage the near-term balance sheet pressures on the extended relief, as they did in FY21, but there are also risks to their capital and earnings buffers from a protracted asset-quality cycle.
State banks are more at risk given their average common equity tier 1 is around 600 basis points lower than that of private banks, while the latter's average return on assets is four times higher than state banks, it added.
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