Bad loans may increase to 12% by March: Fitch report

Banks are struggling with slow resolution mechanisms, concentration risk and weak sectors continuing to dominate their books


The government’s recent move to demonetize Rs500 and Rs1,000 banknotes will adversely impact a number of small businesses which are dominated by cash, says an analyst. Photo: Reuters
The government’s recent move to demonetize Rs500 and Rs1,000 banknotes will adversely impact a number of small businesses which are dominated by cash, says an analyst. Photo: Reuters

Bad loans at banks are set to rise as they struggle with slow resolution mechanisms, concentration risk and weak sectors continuing to dominate their books.

According to an estimate by Fitch Ratings released on Tuesday, the level of stressed assets in the system is likely to go up to 12% by March, from 11.4% a year ago.

The increase in the level of stressed assets will also be driven by slow credit growth in industrial sectors and the vulnerabilities that might be created in the retail portfolio of banks due to the increased impetus on the segment, the report noted.

“State banks have a challenging task ahead in terms of NPL (non-performing loan) resolution. Write-offs well exceed recoveries and upgradations across banks,” said Saswata Guha and Jobin Jacob of Fitch Ratings in their report.

Other analysts seem to agree with the assessment. According to Sri Karthik Velamakanni, research analyst at Investec Capital Services Ltd, while the reduction of fresh bad loans in the July-September quarter is a positive for the sector, any expectation of a major turnaround on the asset quality situation of banks might be a little premature.

Moreover, the government’s recent move to demonetize Rs500 and Rs1,000 banknotes will adversely impact a number of small businesses which are dominated by cash, Velamakanni said.

“Banks have been depending on retail loans for the last two years to ensure their credit growth remains at around 9-10%. Once the self-employed segment among retail borrowers is impacted due to the demonetization, credit growth may deteriorate further,” Velamakanni added.

In the fortnight ended 28 October, the banking sector reported a 9.2% year-on-year credit growth, where the banking system had outstanding advances worth over Rs73 trillion. Total deposits rose 9.6% from last year to Rs99.8 trillion.

Following the demonetization announcement, banks have been able to garner deposits worth Rs5.11 trillion, while Rs1.03 trillion went out of the system as cash withdrawals from automated teller machines (ATMs) and branches.

Guha, a director at Fitch, believes that the large amount of low-cost deposits that has come into the system might not directly result in a lending rate reduction. Banks, he says, might want to hold back on full transmission to improve their margins at a time when there is a build-up of bad loans on their books.

Besides, the public sector banking system is also suffering from a shortage of capital and the government’s capital infusion announcements aren’t giving much comfort to analysts.

According to the Fitch report, the long-term sustainability of additional tier 1 bonds (AT1) will be an issue because of sharply dropping yields and their private placement character. AT1 bonds are perpetual bonds with a call option on a pre-determined date. Banks are relying on this tool in an attempt to comply with Basel III norms, under which they are required to have a tier 1 ratio of 7%.

“Such instruments may not be able to generate widespread support from overseas investors unless pricing compensates for investor’s risk perceptions and the instrument’s loss-absorbing character,” noted report.

Only State Bank of India has issued these bonds to foreign investors. Basel III regulations provide for banks to have a minimum capital ratio of 9% by 31 March 2019.

Recent tweaks to the central bank sustainable debt-restructuring guidelines issued this month may help with further resolutions, the report said.

According to Fitch Ratings’ estimates, banks will require around $90 billion in new total capital by March 2019 where the bulk of the requirement is concentrated in the fiscal years 2018 and 2019.

Under the Indradhanush programme launched last year, the government will infuse Rs70,000 crore in public sector banks till fiscal year 2019, out of which Rs25,000 crore each will be infused in fiscal 2016 and 2017 and Rs10,000 crore each in the next two years.

The estimates suggest that the government has infused Rs22,915 crore so far for the current year.

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