Global rating agency Moody’s Investors Service’s changing of the outlook for the Indian banking system from “stable” to “negative” is hardly a surprise. The stock market had already priced in the deterioration in the outlook for Indian banks. That is why the BSE Bankex has done much worse than the Sensex in the current fiscal year. Banking analysts have been warning of the tough environment for Indian banks for a long time.
The reasons are not hard to find. Growth is slowing, which means that loan growth, too, will slow. The rate increases by the central bank and high government borrowing had led to a scramble for deposits, and the cost of funds has increased. Slowing growth makes it difficult for banks to pass on the increase in borrowing costs, putting pressure on net interest margins. The recent deregulation of interest rates on savings deposits will also raise funding costs. The increase in the government’s borrowing programme has led to a spike in bond yields, which could lead to higher provisions.
The biggest concern about the banking system has been that the slowdown will lead to an increase in bad loans. The concern has been vindicated by the rise in non-performing assets at State Bank of India (SBI) during the September quarter. There’s nothing particularly surprising about this —the downward leg of every business cycle sees a rise in bad loans. But this time, there’s the additional risk that overdues from power companies may mount, simply because the state governments are reluctant to raise electricity tariffs. The Union government has also been dragging its feet on injecting capital into SBI—a factor that led to the bank’s downgrade by Moody’s last month.
But there are also quite a few positives for the Indian banking sector. While it may not be in the pink of health, it compares favourably with many global banks. Moody’s has acknowledged that the stable deposit base of Indian banks and the high level of government securities holdings act as a buffer against funding and liquidity shocks. Government ownership of a large chunk of the country’s banking system also insures against shocks. And distressed loans can be restructured, giving companies breathing space until the cycle turns. Also, as it’s very likely, the interest rate cycle has topped out, which is positive for banks.
Nevertheless, the critics of global rating agency actions do have a point; in view of the fiscal strains in the developed world, it’s time to reassess their sovereign ratings vis-à-vis emerging markets, which in turn will affect bank ratings. For instance, given its fiscal mess and lack of growth, there’s no reason why Italy should have a higher sovereign rating than India.
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