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Moody's outlook on Indian banks remains stable as recovering economy paints a positive picture ahead

Moody's believes gradual economic recovery will support Indian banks' financial fundamentals. (Bloomberg)Premium
Moody's believes gradual economic recovery will support Indian banks' financial fundamentals. (Bloomberg)

  • Expecting the banking sector's financial fundamentals to improve ahead, Moody's in its research note said, declines in loan-loss provisions and increases in net interest margins will boost banks' profitability. Capitalization, funding, and liquidity will be stable and support loan growth.

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US-based Moody's Investors Service has maintained its stable outlook on the Indian banking system as operating conditions of the sector are seen steady on account of improving consumer and business confidence along with domestic demand. According to the rating agency, gradual economic recovery will support Indian banks' financial fundamentals.

Expecting the banking sector's financial fundamentals to improve ahead, Moody's in its research note said, declines in loan-loss provisions and increases in net interest margins will boost banks' profitability. Capitalization, funding, and liquidity will be stable and support loan growth.

In Moody's opinion, banks operating environment will be stable as the economy gradually recovers from the pandemic.

Moody's expects India's economy to continue to recover in the next 12-18 months, with GDP growing 9.3% in the year ending March 2022 (fiscal 2022) and 8.4% in the following year.

It said, "improving consumer and business confidence, as well as improving domestic demand, will support economic growth and credit demand. However, the global economic fallout from the Russia-Ukraine military conflict will create some risks as it fuels inflation because of rising oil prices and driving down the value of the local currency, which will increase pressure on India's central bank to raise interest rates. Increasing corporate earnings and easing funding constraints for non-bank finance companies, which are significant borrowers from banks, will support loan growth."

"We expect growth in bank loans to accelerate to 12%-13% in fiscal 2023 from 5% in fiscal 2021," Moody's said in its note.

Moody's sees banks' asset quality to improve with non-performing loan (NPL) ratios to decline due to recoveries or write-offs of legacy problem loans while the formation of new NPLs will be stable as the economy recovers.

The loan growth will help banks push NPL ratios down by expanding the overall pool of loans, even though new defaults may arise from loans that have been restructured because of economic disruptions from the pandemic, Moody's highlights.

Moody's note said, "The quality of corporate loans will be stable, supported by growth in earnings and a cleanup of legacy problem loans to corporates, while risks will linger in loans to retail borrowers and small and medium-sized enterprises because relief measures for them have somewhat masked stress among them."

As of December 31, 2021, the asset-weighted average of rated banks' gross NPL ratios nearly halved to 5.7% from a peak of 10.3% that was recorded at the end of March 2018.

Further, banks' capital will be stable. Moody's said, "improving profitability will offset increases in capital consumption due to an acceleration in loan growth, helping banks across the system maintain capital at current levels. Capital ratios at public sector banks (PSBs) have improved in the past year, helped by capital infusions from the government. Also, PSBs, as well as their private sector banks, have proactively sought to raise capital from the equity capital market, taking advantage of improvements in profitability to attract investor interest."

By end of 2021, the rated private sector banks had an asset-weighted average Common Equity Tier 1 (CET1) ratio of 15.8%, which in Moody's view, positions them well to capture opportunities to grow loans as economic conditions improve.

However, government-owned banks capitalization remains weaker than that of their private-sector peers, but Moody's also states that their asset-weighted average CET1 rose to 10.5% by 2021-end from 10.0% as of 31 March 2021. Adding, Moody's said, further improvements in PSBs' financial health will continue to help them raise equity capital from the market, reducing their dependence on capital support from the government.

Profitability will improve due to growth in pre-provision earnings and declines in loan-loss provisions.

As per Moody's, gradual increases in domestic interest rates will boost net interest margins because banks will be able to pass on higher rates to borrowers, while their funding costs will increase marginally because banks have reduced the share of high-cost corporate term deposits in total deposits. Stable asset quality and existing provisions against legacy stressed assets will allow banks to reduce loan-loss provisions. The return on assets of rated PSBs and private sector banks rose materially to 0.6% and 1.5%, respectively, in the nine months ended December 2021 from -0.4% and 0.7% in the fiscal year ended March 2018.

In regards to funding and liquidity, Moody's expects them to be stable for both public and private sector banks. Moody's highlights that deposit growth will slow because corporates and individuals will use excess cash for consumption and new business opportunities. Still, increases in low-cost current and savings account deposits will help banks keep funding costs stable even as interest rates rise.

For public sector banks, Moody's believes government support to remain very strong. But in the case of private sector banks, the rating agency expects government support to vary, based on each bank's systemic importance.

Lastly, for resolving a distressed private sector bank, Moody's expects the Reserve Bank of India to impose losses on holders of Additional Tier 1 and Tier 2 securities before the government steps in to support its depositors and senior creditors.

 

 

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