The coronavirus (COVID-19) pandemic may set back the recovery of India's banking sector by years, which could hit credit flows and, ultimately, the economy. Non-performing loans (NPLs) in India will hit a fresh high, raising credit costs, and putting pressure on ratings, says ratings agency Standard & Poor's (S&P).
According to a report "COVID And Indian Banks: One Step Forward, Two Steps Back," published by S&P Global Ratings, Indian banks' NPL ratio could increase by about 50% in the current fiscal year and it will take 12-18 months to get Indian financial institutions sector recovery back on track, leading us to our recent negative ratings actions on lenders.
"In our base case, we expect the NPL to shoot up to 13%-14% of total loans in the fiscal year ending 31 March 2021, compared with an estimated 8.5% in the previous fiscal year," says S&P Global Ratings credit analyst Deepali Seth-Chhabria. "Moreover, the resolution of these bad-debt situations will likely unfold slowly, which means banks may also be saddled with a huge stock of bad loans next year. We assume only about a 100 basis points (bps) improvement in nonperforming loans in fiscal 2022."
According to S&P, after years of deterioration, asset quality in the Indian banking system had improved over the past 18 months, helped by higher write-offs, slower accretion of bad loans, and resolution of some big cases under the new bankruptcy law. Nevertheless, it says, Indian banks were still working through a formidable overhang of nonperforming assets when the COVID crisis struck and this largely derailed that rehabilitation process.
"We believe that the effect on finance companies will be more pronounced than on banks," said S&P Global Ratings credit analyst Geeta Chugh. "Some finance companies lend to weaker customers and have high reliance on wholesale funding. These companies were already facing a trust deficit since the 2018 default of Infrastructure Leasing & Financial Services (IL&FS). Finance companies also face accentuated liquidity risks due to high proportion of borrowers opting for loan moratorium."
S&P says it assume India's GDP will contract 5% in the fiscal year ending 31 March 2021, which will translate into diminished asset quality for Indian financial institutions over the next couple of years.
The ratings agency says it expects credit growth to remain weak in the current fiscal year. "We estimate low single digit loan growth for the system for the current year, mainly driven by government-guaranteed small businesses loans and the capitalisation of accumulated interest."
ON 26 May 2020, the Indian government launched a Rs3 trillion emergency credit scheme for micro, small and midsize enterprises (MSMEs), to help them weather the pandemic.
"Otherwise, lending should remain slow due to tepid demand, and because banks have turned risk averse (despite ample liquidity). Among the risks to our assumptions, the government may push public-sector banks to revive credit growth to support the economy," S&P says.
The ratings agency sees slippages to shoot up in banking sector. It says, "In our base case, we estimate the banking sector's bad loan accretion will be 6% of existing loans in the current fiscal year, much higher than other large Asian banking sectors. If Reserve Bank of India (RBI) allows restructuring of loans, it may reduce the level of slippage this fiscal. However, in our view, restructuring may not resolve the problem. It may just defer NPL recognition, as it did a few years ago."
At that time, S&P says, following rampant restructuring, the RBI had to come up with an asset quality review and withdrew forbearance on the majority of restructured loans, leading to exceptionally high credit costs.
"Businesses' operational outages and the recession will have a deeper and longer effect on lenders than we previously assumed. We believe service sectors such as airlines, hotels, malls, multiplexes, restaurants, and retail may see a significant loss of revenue and profits due to the outbreak. In addition, highly leveraged sectors--real estate developers, telecom companies and power firms--may remain a source of increased bad debt," it added.
According to S&P, MSMEs will likely be most vulnerable in this down cycle. Under the government credit guarantee plan, MSMEs with up to Rs250 million of debt can borrow an extra 20%. The government will entirely guarantee the incremental loans. The program's Rs3 trillion size equals about one-fifth of outstanding MSME credit.
"This will provide some reprieve to the MSMEs that were going through a stressful period after twin effect of demonetisation (where the government in 2016 ruled certain high denomination notes as invalid, creating cash shortages) and the operational challenges of handling a new goods and services tax, rolled out in 2017," it added.
The rise in bad loans should lead to heightened credit costs for lenders, the ratings agency says, adding the credit costs will likely increase again in the current fiscal year and surpass the highs seen in fiscal 2018.
It says, "We anticipate credit costs will rise to about 3.7% of average loans in fiscal 2021. This cost should drop to 2% in fiscal year 2022, but this would still be above the 15-year average of 1.5%."
Talking about recapitalisation of banks, the ratings agency says, most public-sector banks (PSBs) improved their capitalization last year, which should provide some support. The common equity Tier-1 ratio of PSBs was 10.1% as of 31 December 2019, higher than the regulatory requirement of 8% (including a capital conservation buffer). Similarly, the Tier-1 ratio was 11.1%, higher than the regulatory requirement of 7%.
In its base case, S&P says, government-owned banks as a whole should be able to absorb the estimated credit losses without breaching the regulatory minimum, but these banks need capital to grow. "In our base case, where we have factored in 4%-5% credit growth for government-owned banks in the current fiscal year, and we estimate that the government-owned banks need about Rs350 billion to Rs400 billion of capital this year. That is less than what the government pumped into the lenders in the recent past. The requirement may vary from bank to bank, depending on the growth and level of provisioning. In our view, the government will likely infuse capital into these banks, if and when required, even though they haven't provided for any capital infusion in the current year's budget."
"On the other hand, the private-sector banks that we rate are well capitalised and should be able to absorb the increase in provisioning. Moreover, these banks have more capacity to raise external capital than public-sector banks, if required. For example, ICICI Bank has recently divested its stakes in some of its insurance subsidiaries. Moreover, we expect the bank will structurally improve its capital position and balance sheet over the next 12-18 months, which will offset the impact of deteriorating operating conditions and may support ratings at the current level," the ratings agency added.