Moody’s Sees Stable Outlook For Indian Banks
The rate of asset quality deterioration is expected to be lower than the last five years
Slower asset quality deterioration and strong liquidity support are the main factors behind a stable outlook for the Indian banking system for the next 12 to 18 months.
According to a Moody’s Investors Services report, the asset quality of Indian banks is close to hitting the bottom of the cycle. Despite asset quality being a negative factor in credit profiles of most Indian banks, the rate of deterioration of asset quality is expected to be lower than what was seen in the last five years, the report said.
While the stock of impaired loans may still increase during the horizon of this outlook, the pace of new impaired loan formation should be lower than what it has been over the last few years.Srikanth Vadlamani, Vice President and Senior Credit Officer, Moody’s
Asset quality is expected to remain weak for the next 12 to 18 months, however, the weakness will mainly represent the borrowing spree by corporates between 2009 and 2012.
A look at Axis Bank’s watchlist of stressed corporate loans show that 79 percent of the banks current impaired loans originated between FY10 and FY12.
Moody’s believes that a major portion of legacy issues in the loans given during this period have already been accounted for.
The Reserve Bank of India’s asset quality review has led to banks recognising a significant proportion of bad loans.
Moody’s estimates that the ‘true’ level of stressed assets is around 1-1.5 percent higher than the numbers reported at the end of the first quarter. To put this in perspective, before RBI’s call for asset quality review, the number stood at 2.5 to 3 percent. Gross non performing assets of banks stood at 8.7 percent of total loans at the end of the June quarter.
The underlying asset trend of Indian banks will remain stable because of a generally supportive operating environment.Moody’s Investors Services Report
Capital concerns for state-owned banks
The performance of state-owned banks and private banks continues to diverge, noted the report.
Weak capital levels have been a key credit constraint for state-owned banks. These banks are expected to find it tough to meet the capital requirements under Basel III guidelines.
The banks need a CET1 (common equity) ratio of 9.5 percent by 2019 under the new guidelines. Generating internal capital will be difficult for state-owned banks due to their high credit costs, the report said.
The state-owned banks will require significant capital over the next three years with limited access to the capital markets, while the private banks benefit from solid capitalization and good profitability.Srikanth Vadlamani, a Moody’s Vice President and Senior Credit Officer, said in the report.
According to Moody’s, low valuations of state-owned banks’ will prevent them from raising fresh equity in the capital markets. As a result, these banks will have to rely on capital infusions from the government.
However, the capital injections worth Rs 45000 crore over the next 3 years announced by the government, may not be adequate.
A potential way to overcome the capital deficit will be to slow loan growth to single digits over the next three years, Moody’s said.
This won’t be a problem for private banks who enjoy high capital levels and generate enough profits to support their loan growth.
Mixed operating environment
The operating environment for banks will be mixed, despite a largely favourable economic outlook for India, the report stated.
According to Moody’s, in a baseline scenario, headline gross domestic product is expected to grow at around 7.4 percent over the next two years, compared to 7.3 percent in 2015. Favourable monsoons, public investments and rapidly growing foreign direct investments will be the driving factors for GDP growth.
However, private investment trends have been hampered by low capacity utilisation and weak corporate balance sheets. This means that the demand for bank credit is expected to remain subdued over the next 12 months.
We expect system loan growth to measure around 10-12% over the next 12 months, compared to 9% in 2015, with risks to the downside. While retail loan growth should continue to be robust, there is little visibility for a pick-up in corporate credit growth. In addition, blue chip corporates are increasingly looking to tap the corporate bond market, thus further dampening demand for bank credit.Moody’s Investors Services
Ample Liquidity and Funding
Liquidity and funding remain the bright spots for the Indian banking system.
Loan-deposit ratios (LDRs) have been on a decline due to subdued loan growth. With loan growth expected to be muted over the next 12 months, Moody’s expects the LDRs to remain below historical averages. LDRs are used to assess a bank’s liquidity position. A higher LDR suggests that the bank may not have enough liquidity to cover any unforseen funding requirements.
Liquidity of Indian banks is also supported by the abundance of liquid asset holdings on their balance sheets. The reported liquidity coverage ratios of Indian banks are conveniently above the minimum regulatory requirement, according to Moody’s.
Indian banks continue to be well funded led by retail deposits. The market share in deposits has remained stable over the last five years, even when the banks were facing intense asset quality problems.