A rise in risk appetite among Indian banks highlights the importance of assessing individual banks' ability to withstand both expected and unexpected balance-sheet stress as part of an analysis of their intrinsic creditworthiness, says Fitch Ratings.
Indian banks' loan growth over the financial year ended March 2023 (FY22-23) reached 15.4%, the highest since FY11-12, the rating agency says. "We believe this partly reflected pent-up credit demand following the COVID-19 pandemic, as well as strong nominal growth in gross domestic product (GDP), and we expect some normalisation in FY24. However, rapid loan growth and higher exposure to certain asset classes are likely to indicate greater risk appetite and could affect risk profiles. Increasing risk appetite reflects banks' efforts to boost returns after funding costs rose over 2022, even as they manage asset growth relative to capital."
Notably, Fitch says credit card lending and personal loan exposure rose to 10.2% of system loans by FY(estimate)E22-23, from 7.5% at FYE17-18. "We view such unsecured categories as most vulnerable to potential stress, though exposures among our rated entities remain manageable, and improvements in risk controls and loan-book granularity should help to reduce risks associated with any future asset-quality deterioration relative to previous cycles. We also expect tighter regulatory supervision to slow unsecured lending in the year ahead," it added.
According to Fitch, exposure to non-bank financial companies (NBFCs) within the services sector has also risen to 10.5% in FY22-23 from 6.5% of total system loans in FY17-18. Funding pressures and asset-quality risks among NBFCs have receded since that sector underwent a stress period in 2019. These loans are also typically to well-established private and State-owned entities; so they carry less risk than unsecured lending.
However, NBFCs, like banks, are also increasing their risk appetite, the rating agency says, adding, "We expect banks to continue to lend to the sector, but at a slightly slower pace as more banks run up against regulatory sectoral-concentration caps."
As per Fitch's estimate, the banking sector's capital buffers have strengthened, with the FYE22-23 average common equity tier1 (CET1) level at 13.1%, versus
10.4% at FYE18. It says larger buffers may help to offset the effect of increased risk appetite on credit profiles, but a substantial difference remains between the average at state banks at 11.6% and that at private banks at 16.1%.
"We forecast India to be one of the fastest-growing Fitch-rated sovereigns at 6% in FY24 and 6.7% in FY25. This supportive operating environment (OE) should offer banks opportunities for profitable business, and points to limited balance-sheet risks under our base case. It should also reduce risks around the unwinding of forbearance measures from FY24," the rating agency says.
Nonetheless, according to Fitch, high-risk appetite has historically been a contributing factor to the deterioration in some Indian banks' financial profiles, particularly when OE conditions turn less benign. "State banks were more severely affected than private banks during the last asset-quality cycle downturn, as they have lower buffers and tend to be more influenced by government's strategic priorities."
With improvement in financial performance, the rating agency sees the current supportive conditions to offer opportunities for banks to strengthen capital buffers further.
The impaired-loans ratio for the sector improved by roughly 200bps (basis points) in FY22-23, to 4%, supported by higher loan growth and the write-off of legacy bad loans. Loan-impairment charges per loan also dropped to 0.7%. Lower credit costs helped to lift return on assets to 1.1%, the highest in a decade.
The issuer default ratings (IDR) of Fitch-rated Indian banks are all support-driven but, it says, risk profiles play an important role in its assessment of standalone viability ratings (VRs). "If we assess a bank's risk profile to have deteriorated, this could result in a negative adjustment factor in its VR. We currently make negative adjustments to three Indian bank VRs to reflect their risk profiles," it concluded.