The improved financial metrics of Indian banks do not fully reflect the impact of the coronavirus pandemic, and bad loans and credit costs are likely to rise as liquidity tightens, Fitch Ratings said on Monday.
The impact of the COVID-19 pandemic is likely to pose challenges to Indian banks' improving financial performance once asset-quality risks manifest in the financial year ending March 2022, it said.
"The operating environment remains challenging as the sector tries to balance a gradually recovering economy with preserving moderate loss-absorption buffers. Fitch expects both impaired loans and credit costs to rise as forbearance and easy-liquidity conditions ease," the credit rating agency said.
It said the state-owned banks are more vulnerable than private banks, given their participation in relief measures, while their earnings and core capital buffers are weak.
"Fitch expects a moderately worse sector outlook for Indian banks for 2021-2022 based on muted expectations for new business and revenue generation, and deteriorating asset quality. The state's less-than-adequate recapitalisation plans for its banks further underscores the risk, which will likely keep risk aversion high among banks amid continuing uncertainty about asset quality and an uneven economic recovery," Fitch Ratings said in a release.
Hit by the pandemic and the subsequent nationwide lockdown to control the spread of infections, Indian economy contracted by 24.4 per cent in April-June 2020 and 7.3 per cent in July-September quarter of the year. The GDP growth returned to positive territory in October-December quarter, rising by 0.4 per cent.
Indian banks' aggregate non-performing loan (NPL) ratio fell to 7.2 per cent by end-December 2020 as against 8.5 per cent at the end of March 2020. However, NPLs excluded unrecognised impaired loans under judicial stay, restructured loans, loans under watch and loans overdue by over 60 days, which formed 4.2 per cent of loans, Fitch Ratings said.
"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)," it added.
The disproportionate shock to India's informal economy and small businesses, coupled with high unemployment and declining private consumption, have yet to fully manifest on bank balance sheets, Fitch Ratings said.
However, private banks, it said, are better poised to tap growth opportunities in 2021 as their higher contingency reserves offer better earnings and capital resilience. The state-owned banks' average buffer between pre-provision profits and credit costs is only 160 basis points versus private banks' 340 basis points.