Global rating agency Moody’s on Monday said India’s banking system is moving past the worst of its asset quality down cycle. This supports stable outlook for the sector over the next 12-18 months.
The stock of impaired loans may still increase during the horizon of this outlook, but the pace of new impaired loan formation should be lower than what it has been over the last few years, said Srikanth Vadlamani, Vice President and Senior Credit Officer.
The performance of India’s state-owned and private banks, though, continues to diverge. State-owned banks will require significant capital over the next three years with limited access to capital markets. Their private sector counterparts benefit from solid capitalisation and good profitability, he said.
The stable outlook is based on Moody’s assessment of five drivers: Operating Environment (stable); Asset Risk and Capital (stable); Funding and Liquidity (stable); Profitability (stable); and Government Support (stable).
The operating environment for Indian banks is supported by a stabilising economy. Moody’s baseline scenario assumes headline GDP growth of 7.4% over the next two years, compared with 7.3% in 2015, with key drivers being a favourable monsoon, ongoing public investment, and continued growth in foreign direct investment.
Asset quality will remain a negative driver of the credit profiles of most rated Indian banks. But, the pace of deterioration should slow, according to report titled, “Banking System Outlook — India: Bottoming Asset Cycle, Strong Liquidity Support Stable Outlook”.
Aside from legacy issues for some banks, the underlying asset trend for Indian banks will be stable because of the generally supportive operating environment.
Capital levels remain a key credit weakness for state-owned banks. The announced capital infusion plans of the government fall short of the amount required for their full capitalization. However, Moody’s says a potential way to bridge this capital shortfall would be to slow loan growth to the low single digits over the next three years.
Funding and liquidity remains a bright spot for the system, and will remain supported by Moody’s expectation of relatively subdued loan growth during the outlook.
Profitability for the banks will reflect stabilizing net interest margins (NIMs) and credit costs. Moody’s expects limited policy rate cuts over the next 12 months, which should help stabilize NIMs. Credit costs will remain high for the sector, but no higher than in recent years for the industry overall.
The state-owned banks will receive a very high level of systemic support, irrespective of their size. Recent government allocations, wherein weak smaller banks received a disproportionately higher share of capital, support this view, Moody’s added.