Indian banks may continue to face heightened asset quality and earning pressure for at least two years, as disruption to business activity and supply chains and shrinking personal incomes damage banks' balance sheets, according to a report by Fitch Ratings.
The reported performance of Indian banks for the financial year ended March 2020 does not adequately reflect the incipient stress caused by the pandemic, the rating agency said in the report titled 'Indian banks vulnerable to pandemic related stress'.
"Bank balance sheets are yet to feel the impact of India's strict lockdown measures that were implemented by the government from March 25. Moreover, a meaningful short-term recovery looks unlikely, as the acceleration of new COVID-19 cases threatens the gradual reopening of the economy," it said.
The impaired loan ratios of Indian banks fell during 2019-20 in line with our expectations to 8.5 per cent in 2019-20 from 9.3 per cent in 2018-19, driven by fewer fresh impaired loans and continued write-offs. Several state-owned banks also returned to profitability due to easing credit costs, but the banking sector's return on assets was low.
"Fitch expects heightened asset quality and earning pressure for at least the next two years, as disruption to business activity and supply chains, as well as shrinking personal incomes, damage banks' balance sheets, it said.
Public sector banks (PSBs) were more vulnerable than private sector banks coming into the crisis, with weaker loss-absorption buffers, and appear to be shouldering a disproportionate share of the burden in bailing out affected sectors, it added.
Indian banks are likely to require at least USD 15 billion in fresh capital to meet a 10 per cent weighted-average common equity tier-1 ratio under a moderate stress scenario, Fitch said.
The amount would rise to about USD 58 billion in a high-stress situation where the domestic economy fails to recover from the coronavirus pandemic-related disruption.
PSBs will require the bulk of the recapitalisation, as the risk of capital erosion at the state-owned banks is significantly higher than their privately-owned peers.
"We expect the majority of the injection to come through in FY22, as bad loan recognition has been pushed back by a 180-day regulatory moratorium. However, a clearer picture should start to emerge from December 2020, unless the central bank agrees to a one-time loan restructuring, which would affect the timely recognition and resolution of bad loans," Fitch said.
A well-functioning banking sector is supportive of achieving sustained economic growth of 6-7 per cent, but without timely and adequate recapitalisation, banks will continue to display heightened risk aversion, adding to India's economic uncertainty, it added.
Fitch expect the economy to contract by 5 per cent in the current financial year, followed by a recovery in 2021-22, but with considerable downside risk to its forecast.