Fitch Ratings has revised its operating environment mid-point score for Indian banks to 'bb', from 'bb+', as increasing challenges from the coronavirus pandemic are expected to worsen an already difficult operating environment. The ratings agency's outlook on the operating environment is 'negative' due to the uncertainty surrounding the severity and duration of the pandemic and the associated effects on India's banks of restrictions on economic activity.
In a report, the ratings agency says, "The banking system remains under-capitalised and saddled with bad loans despite some progress in resolving these issues. We believe recent developments will add to these issues and slow the resolution process. It will further test the underwriting standards of those banks that expanded the fastest in recent years, including the private-sector banks, as the sharp disruption in economic activity will lead to worsening asset quality."
"Steps by the Reserve Bank of India have thus far focused on shoring up liquidity in the banking system and ensuring currency stability, but we believe there will be additional measures from the authorities to mitigate the impact of the outbreak," it added.
India's banks already faced weak business and consumer confidence, which were among the factors that prompted Fitch to lower our operating environment score for India's banking sector to 'bb+' from 'bbb-' in 2019.
The country on 24 March 2020 entered a 21-day lockdown, which will affect industrial production and domestic demand. This will exacerbate the economic slowdown of the past few quarters that was partly caused by weaker credit availability from non-bank financing institutions (NBFIs) from September 2018. Now, global risk aversion has hurt India's financial markets despite fewer cases of infection than many other countries, although the number may increase as testing ramps up.
Fitch estimates that India's GDP growth will slow to 5.1% in the financial year ending March 2021, from a pre-pandemic forecast of 5.6%, following growth of 5.0% in FY2020. "So far, the expected impact is less severe than for other markets in Asia due to the relatively closed nature of the economy. However, developments have been rapid and downside risks to the estimates are high as Fitch's growth forecasts were published before the lockdown," it added.
According to the ratings agency, travel-related sectors (2.2% of total sector loans) along with micro and small and medium enterprises (SMEs) (5.4%) will be the hardest hit, with additional indirect exposure via NBFIs, including housing finance companies, which account for 12% of sector loans.
In addition, Fitch says, sectors that rely on supplies from China (such as auto, pharmaceuticals and electronics) will also be affected. It also believes that the impact could easily spill over into banks' retail businesses, particularly unsecured retail loans (9%, including personal loans), as unemployment rises.
Fitch says it does not expect Indian banks' issuer default ratings (IDR) to face downward rating pressure in the near term as they are based on support from the India sovereign and are at their support ratings floors. However, it says, banks with Viability Ratings (VRs) that are above the operating environment score do face greater pressure compared with lower-rated peers, as Fitch believes that a bank's operating environment constrains its viability rating and other factor scores due to the environment's influence on bank's risk profile.
As per the ratings agency, ICICI Bank's and Axis Bank's VRs are rated above the operating environment mid-point score, which makes them susceptible to downward VR pressure, even though they have better income and capital buffers.
Fitch says, "State-owned banks are also vulnerable as their average common equity Tier 1 capital ratio of 10% is 300bp lower than that of private-sector banks, while their income buffers are also very weak, making them highly susceptible to even moderate stress. However, most state-owned banks also have lower VRs to begin with, except for State Bank of India."