Fitch: Stable outlook for Indian banks despite challenges

Growing concentration risk has resulted in banks having a greater proportion of stressed assets than in 2008.

Written by Agencies | Published: January 23, 2012 1:25 pm

Fitch Ratings says that the outlook for Indian banks remains stable in 2012,premised on domestic economy recovery in 2012,together with the government’s continued commitment to maintain a minimum Tier 1 ratio of 8% for its banks (73% of system assets). While this is a base-case scenario,a build-up in credit concentration and weakening asset quality reflect mounting downside pressures.

Part of the credit problem is cyclical and may ease with a lag if GDP growth picks up from mid-2012 on the back of lower interest rates to stimulate demand,as the Reserve Bank of India may look to loosen monetary policy if core inflation eases. However,should the Indian economy continue to slowdown through most of 2012,the resulting problems relating to asset quality could hurt banks’ stand-alone credit profile and their Viability Ratings (VR).

The structural part of the problem relates to the growing concentration risk that has resulted in Indian banks having a greater proportion of stressed assets than in 2008. Exposures to the struggling sectors of aviation and state power utilities may be restructured in 2012,together with growing exposures to infrastructure projects that face teething trouble. As a result,Indian banks may see the share of loans restructured in 2011 and 2012 rising to 7%-8% of loans,significantly higher than the 4.4% seen in the aftermath of the 2008 crisis.

Credit losses may however remain contained. While the immediate outlook on Indian infrastructure is negative,the long-term viability of the projects – which is still intact – may help limit credit losses. Since these exposures to stressed assets are very thinly reserved,government banks’ profits may be impacted by 15%-20% due to higher loan loss provisions. Nevertheless,pre-provision operating profits of banks are seen as being adequate to absorb the rising costs,leaving equity intact.

Infrastructure growth will remain a thrust area for the government,and cash-rich state-owned companies were recently advised to step-up investments in new projects. Till now,government banks were the largest source of long-term loans for infrastructure projects,but have become cautious as stresses increase. Though unlikely,any significant increase in the share of infrastructure loans leading to further weaknesses in asset quality and funding could impact the standalone credit profile of banks and lead to a downward pressure on their VR.

The government is expected to play a key role in maintaining stability of the banking system through periodic injections of core equity. Fitch understands that a 10-year capitalisation plan is under consideration,which includes maintaining majority shareholding and targeting a core Tier 1 ratio of at least 8% – possibly more for the larger,systemically important banks. The timeliness of such injection,which cannot always be predicted with certainty by management,may come under pressure as the government struggles with containing the fiscal deficit. If delays in equity injection turn chronic,it may impact the Issuer Default Ratings of government banks.

Funding has been the traditional strength of Indian banks,being largely driven by customer deposits with a loan / deposit ratio of around 75%. The share of short-term deposits has,however,been increasing for government banks,reflecting the funding strains of above-average loan growth,leading to rising funding gaps. The latter increase the risk of volatility in net interest margins,particularly during the current period of high interest rates and tight liquidity.

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