Indian banks' asset quality pressures feared to persist

Will they ever get out of this problematic hole?

Fitch Ratings says that the asset quality indicators for Indian banks continue to deteriorate and will likely reach levels much worse than previously expected due to further weakening in the economic environment.

Indian banks reported a rise in stressed assets to 9.1% of total loans (NPL ratio: 3.4% and restructured loans ratio: 5.7%) in the financial year ending March 2013 (FY13) from 6.1% in FY12.

Here's more from Fitch Ratings:

This figure rose by close to 100bp to 10% in Q114 (NPL ratio: 3.9% and restructured loans ratio: 6.1%). Fitch expects the proportion of stressed assets to peak at around 15%.

Indian banks' stress tolerance has weakened and this has resulted in the downgrade of Viability Rating (VR) at several state-owned banks recently. Private-sector banks have a superior credit profile supported by their robust earnings profile, lower stressed assets and strong capital position. This relative resilience is highlighted by the outcome of Fitch's stress tests, with the tolerance remaining largely intact for the private sector banks.

Those state-owned banks' whose earnings and capital buffers have not kept pace with the significant asset quality deterioration, even with the state's regular injections of capital, will likely experience more pressure on their VRs. The private-sector banks, helped by robust profitability and strong capitalization buffers are better positioned to face the economic slowdown, which is likely to be more prolonged than previously expected.

The agency has revised its full-year FY14 forecast for real GDP growth down to 4.8% in FY14 and 5.8% in FY15, from previous projections of 5.7% and 6.5% respectively. Sharp depreciation in the Indian rupee has further weakened consumer and business confidence and complicated matters for policymakers, who are already trying to combat persistent inflation in the economy.

Indian banks' loan growth moderated in FY13 (13.5% vs growth of 17% in FY12), although the concentration in the infrastructure and cyclical sectors have remained largely unchanged. The financial metrics at some of the sub-sectors (such as, power, steel, construction) are stretched and Fitch expects these sectors to contribute the bulk of the expected stress on Indian banks.

State-owned banks' in the last four years have benefitted from regular capital injections, but their dependence on this form of support has grown as earnings have shrunk consistently over the years. Fitch believes these banks may not seek funding via the equity markets in the near- to mid-term due to their weak performance, adding to their dependence on the state for capital.

Funding for Indian banks is generally satisfactory though liquidity is expected to remain tight in the near-term. Low-cost current and savings deposits account for over 30% of the system's funding base (excluding equity). The share of term deposits has increased, although retail term deposits, which tend to be less volatile, account for nearly half of the term deposit mix.

Mid-tier banks continue to have a larger reliance on costlier bulk and certificate of deposits, which presents refinancing and pricing volatility.