Indian Banks To Weather Near-term Pressure from Rate Hikes: Fitch
Moneylife Digital Team 14 July 2022
Mounting repayment pressure for some borrowers amid India's interest rate hikes, particularly for micro-, small- and medium-sized enterprises (MSMEs), will test banks' loan underwriting quality. However, asset-quality risks from higher rates should generally be moderate for most banks, says a research note. 
In the report, Fitch Ratings says, higher rates will also affect securities valuations and could make it harder for banks to raise fresh capital, particularly at state banks, although wider net interest margins (NIM) will have offsetting positive credit effects.
Last month, the Reserve Bank of India (RBI) raised policy interest rates by 50 basis points (bps) to 4.90%. "We expect rates to rise further, reaching 5.90% by end-2022 and 6.15% by end-2023, then remaining at this level through 2024," Fitch says.
According to the report, banks have been quick to pass on higher rates through loan portfolios, which are mainly floating in nature, but have been slower in raising deposit rates. "This trend should support higher NIM, but the lack of competition for deposits may point to relatively muted demand for new credit. Generally, asset-quality risks from the rate hikes should be manageable for most banks." 
Aggregate corporate leverage has fallen back in recent years and India has a low level of household debt per nominal gross domestic product (GDP), at 14.5% in 2021. Nonetheless, the rating agency expects some areas to experience heightened credit stress.
The RBI's June 2022 financial stability report (FSR) noted that the MSME sector has begun to show signs of revival, while highlighting that risks still persist. "We expect higher rates to pose particular challenges for this sector, and believe that any consequent rise in bank credit costs from asset-quality deterioration could be amplified by the unwinding of regulatory forbearance on COVID-19 affected loans. The unwinding is likely to start from the financial year ending March 2023, assuming authorities do not extend forbearance further," the rating agency says.
Fitch says Indian banks rated by the agency have relatively large securities portfolios compared with other Asian banking markets, and higher bond yields will cause banks to recognise fair value losses in available-for-sale (AFS) portfolios. "However, it is possible that the RBI could reintroduce mechanisms it has used in the past to cushion the impact of rising yields on balance sheet valuations, such as reclassification of some AFS securities to held-to-maturity or allowing mark-to-market value changes to be spread out over several quarters."
The rating agency expects banks' capital buffers to remain commensurate with current ratings in the near term, although weaker capitalisation will be a greater constraint on loan growth at State banks than at private-sector rivals. According to the report, higher interest rates could make raising additional private capital more challenging, making State banks more reliant on equity injections from the government if they are to maintain market share. 
"We believe state banks will lose market share in the next two to three years due to an inability to raise sufficient capital to match the level of loan growth at private banks. However, this is unlikely to affect bank ratings, as the process will be gradual and we expect large state banks to remain among the largest in India's banking system over the medium term," Fitch concludes.
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