Indian banks are profitable again and have strengthened their capital positions, allowing for a new phase of loan growth. However, if risk management does not improve, the coming growth cycle could produce a new crop of bad loans. That is according to a new report published by S&P Global Ratings, titled "As India's Banks Grow Again, Will Old Mistakes Return?"
"Indian banks entered the pandemic on a weak footing yet managed to march on toward recovery," says Deepali Seth Chhabria, credit analyst at S&P Global Ratings. "We believe banks are ready to shift into a growth phase, to meet rising demand as the country's economy recovers."
While banks seem to have learnt lessons from the past bad-debt surges, according to the rating agency, India has not done enough to reform its banks.
"In our view, governance and transparency are weak by global banking standards. More follow-through on governance reforms is required, especially for public sector banks (PSBs). If the growth is not accompanied by better risk management and corporate governance, another bad-loan cycle could ensue," it says.
Barring another major outbreak of COVID-19 in India, S&P anticipates bank asset quality that has hit its nadir to start improving. "By our estimates, the system's weak loan ratio has peaked at close to 10% as of 30 September 2021; this ratio includes non-performing loans (NPLs) and restructured loans as a percentage of the outstanding portfolio," it says.
According to S&P, more substantial balance sheets and higher demand should boost loan growth for Indian banks by more than 10% annually over the next two years, in line with nominal GDP.
However, credit costs—which reflect provisioning on bad loans—will probably hit their lowest level in seven years, which will boost earnings, it added.
Providing further impetus to the banking system is India's strong growth prospects. S&P says it expects the economy's expansion to outpace that of developing-market peers over the next few years.
In comparison, it says some tourism-dependent countries, such as Thailand, are likely to see long-term scarring as it expects only a gradual resumption of travel-related industries.
"Loan growth will be driven by retail credit, an underpenetrated segment for Indian banks," says Ms Seth Chhabria, adding, "Corporate loan demand could be slower to gain traction and be underpinned by working-capital needs over the next year."
S&P sees a recent announcement from Reserve Bank of India (RBI) as positive for financial stability.
RBI is also tightening and equalizing norms for bank licenses, making for a more level playing field, while also increasing overall standards.
The central bank has reviewed and is, for now, refraining from allowing corporate ownership in banks. The idea remains under examination. The RBI working group cited conflicts of interest, the concentration of economic power, and financial stability as potential risks.
"We remain sceptical of allowing corporate ownership in banks, given India's weak corporate governance. We think corporate ownership of banks raises the risk of intergroup lending, diversion of funds, and reputational exposure. Also, the risk of contagion from corporate defaults to the financial sector could soar. In addition, we believe that RBI could face challenges in supervising the nonfinancial sector and it could strain its resources," the rating agency says.