Indian banks' improved performance for the financial year ended March 2021 (FY20-21) contrasts with the stress evident from the extension of COVID-19 related relief measures to borrowers, says Fitch Ratings in a new report.
According to the ratings agency, private banks' considerably better performance than State banks has positively influenced banking system aggregates in addition to deferred recognition of stressed assets that has masked the stress. It says, "Large private banks' deposit franchises experienced resilience despite the failure of two private banks in 2020. However, state banks were dominant because of their wide reach and high depositor confidence owing to their strong linkages with the state."
The Indian banking sector's average impaired loans ratio declined to 7.5% in FY (estimate) E20-21 from 8.5% at FYE19-20, while banks simultaneously extended relief to stressed borrowers affected by the COVID-19 pandemic.
The government's announcement on 28 June 2021 that it would increase the limit of emergency credit line to $60 billion from $40 million to support micro, small and medium enterprises (MSMEs), underscores the challenges posed by the more virulent second wave of infections in the first quarter of FY21-22 (Q1FY21-22) on the most vulnerable sectors in the economy.
It has affected the pace of economic recovery, with Fitch revising down its real GDP growth outlook for FY21-22 to 10% from 12.8%.
"The impaired loans ratio of 7.5% in FY20-21 was moderately better than our expectations. The ratio was supported by declining fresh bad loans as well as high levels of write-offs. Continued relief measures aimed at COVID-19 affected segments, such as MSME, retail and contact services, played a crucial role in deferring recognition of problems with asset quality. We expect impaired loans to peak after FY22-23 since stress is likely to manifest from this pool over a fairly protracted timeframe," Fitch says.
According to the ratings agency, operating environment remains challenging for the banks with limited opportunities for business and revenue growth. "Problems could escalate in the event that successive COVID-19 waves and lockdowns prevent a meaningful economic recovery considering that India's full vaccination rate is still quite low," it says.
Fitch says it expects banks to manage the near-term balance sheet pressures on the extended relief - as they did in FY20-21 - but there are also risks to their capital and earnings buffers from a protracted asset-quality cycle.
"We believe state banks are more at risk given their average common equity Tier 1 is around 600 basis points lower than that of private banks, while the latter's average return on assets is four times higher than state banks," it added.
Fitch Ratings revised down India's real GDP for FY21-22 by 280 basis points (bp) to 10%, underlining its belief that renewed restrictions have slowed recovery efforts and left banks with a moderately worse outlook for business and revenue generation in FY21-22.
The ratings agency says it believes that rapid vaccination could support a sustainable revival in business and consumer confidence; however, without it, economic recovery would remain vulnerable to further waves and lock-downs.
"Regulatory relief measures have postponed underlying asset-quality issues for now, but banks’ medium-term performance will be dented without a meaningful economic recovery," it added.