Final Push For Bad Loan Clean-Up To Hurt Bank Profitability, Says Moody’s

Weaker banks may continue to report losses this fiscal year due to the RBI’s new framework, says Moody’s

Pallavi Nahata @PallaviNahata

03 May 2018, 12:03 PM IST

Indian two thousand and five hundred rupee banknotes are arranged for a photograph in Mumbai. (Photographer Dhiraj Singh/Bloomberg)

The Reserve Bank of India’s new stressed asset framework, which Moody’s Investors Service sees as the final push to clean up bank balancesheets, will strain bank profitability in the near term, the rating agency said in a report on Wednesday.

Moody’s expects the new framework to lead to a reclassification of a large share of restructured loans into non performing loans. For Moody’s rated public sector banks, the overall pool of stressed assets stood at about 16.5 percent of total outstanding loans as of December 2017. This is about 3.6 percentage points higher than the reported NPL ratio of 12.9 percent.

Final Push For Bad Loan Clean-Up To Hurt Bank Profitability, Says Moody’s

At private banks rated by Moody’s, total stressed assets are at about 6.6 percent compared to reported NPLs of 4.7 percent, the rating agency said. Among private sector banks, ICICI Bank Ltd and Axis Bank Ltd have the highest ratio of stressed assets, about 4 percentage points higher than its reported NPL ratio as of December 2017.

The new framework will mean that this gap will converge and NPLs will move closer to the overall stressed asset pool. The result will be larger provisioning and lower profits in the near term.

This will mark the final stage of a multiyear initiative by the central bank to push banks to recognize problem assets more accurately. Consequent increases in already-high NPL ratios and provisioning burdens for banks will strain their profitability in the near term, although cleaner and recapitalized balance sheets are credit positive for the sector in the long term.

Moody’s Investors Service

NPL’s at private sector bank’s also increased though not as much as at PSB’s

In a February 12 circular, the RBI said that existing stressed asset resolution schemes were being withdrawn. Accounts where implementation of these schemes had not concluded would be marked down as NPLs. In addition, the regulator asked banks to start working on a resolution plan as soon as a company delayed payments by even a day. If a resolution plan is not finalised within 180 days, the account must be referred for resolution under the Insolvency & Bankruptcy Code (IBC).

Provisioning for assets affected by the rule change will jump to 40 percent from the current 5 percent, said Moody’s. This will mean that credit costs at public sector banks (PSB’s) rated by Moody’s, will remain high, it said.

Weaker banks may continue to report losses in the next fiscal year, adding further pressure on capital ratios.

The credit profile of these banks, however, may not be affected as the rating agency was already taking into account restructured assets while judging the credit quality of the bank.

While the new rules will lead to an initial rise in NPL ratios, they are expected to stabilise and decline after the next few quarters, according to Moody’s.

Deterioration in bank profitability will be largely offset by the government’s capital infusion in the case of public sector banks, the rating agency said. In the long term, the new rules are largely expected to be credit positive since they will go further in providing clarity and a time bound process for stressed assets resolution.