The problem for the lenders, arising out of these downgrades, is that their cost of overseas borrowings go up. Indeed, Bloomberg shows that the yield on both ICICI Bank’s and Axis Bank’s dollar bonds rose in international trade after the downgrades. But the rise was marginal largely because Fitch’s reasons for the downgrade have already been largely factored in by the markets.
Fitch Ratings’ argument is that there seems to be no resolution in sight for assets stuck in insolvency proceedings and of bad loans outside courts. Considering the slowing of the Indian economy, resolution for banks is going to be tricky.
This means that further additions to bad loans cannot be ruled out, which in turn has implications for capital adequacy and profitability.
“Indian banks are looking at a tough year ahead as resolution is slow. These are known facts, but FY19 has been a good year for some of them. A downgrade now sends a wrong signal," said an analyst from a global brokerage firm, requesting anonymity.
To be sure, analysts believe that the timing of the rating agency’s move is unfair as the lenders reported an improvement in their metrics in FY19.
Both ICICI Bank and Axis Bank reported notable improvement in asset quality compared with their peers. Kotak Institutional Equities in a note pointed out that overall stressed assets dropped 150 basis points sequentially to 11% for ICICI Bank and the fall for Axis Bank was 80 basis points to 9%. A basis point is 0.01%
That said, Fitch Ratings’ downgrade is a wake-up call for Indian policymakers and lenders.
Foreign capital is impatient and to keep attracting it, it is not just necessary to fix the banking sector, but to fix it quickly.
For that to happen, insolvency resolutions should pick up pace and recoveries should increase. Most large corporate lenders have shown encouraging signs in recoveries, but their write-offs too are high. In other words, lenders are simply writing off loans after providing for them through capital, instead of getting their money back from errant borrowers.
As for rating agencies, analysts believe that Fitch’s move may not hurt private sector lenders, but if other rating agencies follow suit, banks would find themselves in a bind for raising capital. Axis Bank has already issued $3.5 billion worth of medium-term notes, while ICICI Bank has raised $3.7 billion through such notes over the last four years.
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