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S&P predicts Indian banking sector revival will take a few years

In a recently released report, S&P Global Ratings claimed that the asset quality and growth of India's banks are likely to remain under stress due to the fragility in financial markets, rising risk aversion, and weakness in some highly leveraged corporate sectors

twitter-logoBusinessToday.In | August 28, 2019 | Updated 14:10 IST
S&P predicts Indian banking sector revival will take a few years
Banking stocks rose 885 points to 31,329 on Monday following FM Nirmala Sitharaman's decision to immediately release Rs 70,000 crore for public sector banks

India's stressed banking sector, weighed down by gross non-performing assets (NPAs) worth Rs 9.49 lakh crore at the end of the last fiscal, has been showing signs of a revival of late. The public sector banks had collectively posted a net profit in the first quarter of FY20, against a net loss of over Rs 13,000 crore in end June last year. The immediate infusion of Rs 70,000 crore for recapitalisation of public sector banks - announced by the government last week - further fanned optimism. But according to S&P Global Ratings, the overall improvement in Indian banks' asset quality "will take a few years".

In an FAQ titled 'What's Hurting Indian Banks' Recovery' released by the ratings agency on Tuesday, credit analyst Geeta Chugh claimed that the asset quality and growth of India's banks are likely to remain under stress due to the "fragility in financial markets, rising risk aversion, and weakness in some highly leveraged corporate sectors", not to mention the absence of much-needed reforms in the sector.

Deteriorating sectoral credit profiles

Referring to the liquidity crunch set off by the debt default crisis at Infrastructure Leasing & Financial Services (IL&FS), S&P pointed out that amid rising risk aversion, lenders are stepping away from companies with perceived governance issues. "In such difficult market conditions, companies that have high leverage at both the promoter and the company level are more vulnerable to a default risk," read the FAQ, adding that about one-fifth of banks' loans to large and midsize Indian corporates have turned non-performing, while about one-tenth of small and midsize enterprises (SMEs) and micro loans are delinquent.

"The creditworthiness of the real estate sector is under pressure," said the report. It pegs banks' exposure to the ailing realty sector at 2.3 per cent of gross banking credit as of June 21. Their exposure to the stressed power sector is much higher at 6.5 per cent. "We expect the credit profile of auto and auto parts companies to deteriorate because they remain susceptible to a global and local slowdown in sales. However, banks' exposure to the auto segment is relatively lower, at less than 1% of gross banking credit," it added.

Bank loan slippages in India is seen to remain high compared with other large emerging markets in Asia. "Slippages will be primarily from highly leveraged corporate entities where the promoters have large financing, real estate developers, and some fincos," said S&P but it does not expect "large contagion or systemic stress".

While the spurt in corporate defaults is expected to be offset by recoveries of existing non-performing loans (NPLs) under the Insolvency and Bankruptcy Code (IBC) framework, the report claims that corporate sector stress will lengthen the domestic banks' recovery period. "We expect only a gradual "U-shaped" recovery for Indian banks," it explained, adding that the recovery significantly hinges on the resolution of large NPLs.

Furthermore, the corporate sector's capacity utilisation is still low, which according to the analysts will push back revival in the private sector by at least one year.

Rising retail non-performing loans

According to the agency, India's retail loans have generally performed very well in the decade following banks' gradually tightening of underwriting standards post 2009 and reported delinquencies are under control. However, as macroeconomic headwinds surge, retail NPLs could inch up, especially if job losses accelerate courtesy the ongoing economic slowdown.

"We expect retail NPLs to rise as the loans season amid a tough operating environment. Also, the rise in the proportion of self-employed borrowers and non-prime borrowers in the past few years will hurt banks' asset quality," the report stated, flagging off high risk of delinquencies in the loan against property (LAP) segment in particular.

Outlook on finance companies and banks

The ratings agency predicts that the growth and profitability of the fincos will remain under pressure, amid rising funding costs and tightened liquidity following IL&FS' default. The curtailed availability of funding has forced players in this space to scale down growth and hold relatively higher liquidity on their balance sheets. It also expects the smaller fincos to increasingly have to resort to an "originate and sell" business model to optimise their large distribution channels.

"We expect banks' credit growth to be in line with the nominal GDP growth," read the report, pointing out that retail loan growth is higher in most categories, barring auto and consumer durable loans. Interestingly, private sector banks are expected to gain market share at the expense of fincos and public sector banks.

The outlook on bank earnings remains less-than-optimistic. Yes, banks will benefit from higher treasury income on their government securities portfolio due to the decline in interest rates this year and their earnings are likely to improve marginally on account of a decline in provisioning costs, lower incremental slippages, recoveries from existing NPLs and higher provisioning coverage. But overall banks' earnings will "remain weak".

Also read: SBI, ICICI Bank, YES Bank stocks rise after govt's recapitalisation announcement

Also read: IDBI Bank share plunges over 11% as S&P puts lender on 'credit watch'

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