Outlook for Indian banks remains negative: Moody’s

MUMBAI: The fundamental credit outlook for the Indian banking system remains negative, having been changed from stable in January 2009, reflecting
the currently challenging economic conditions and the rising level of problem loans, and the resulting adverse implications for asset quality, said Moody's Investors Service in its new Banking System Outlook on India.

Moody's negative outlook for the Indian banking system expresses the rating agency's view on the likely future direction of fundamental credit conditions in the industry over the next 12 to 18 months. It does not represent a projection of rating upgrades versus downgrades.

The Indian banking system remains largely in the hands of the public sector banks (PSBs), with almost 72 per cent of the banking system assets held by majority government-owned banks, while the balance is held by private sector (19.6%) and foreign banks (8.5%).

Moody's main concern about the Indian banking system is the deteriorating asset quality and volume of restructured loans. During fiscal year ending March 2009 (FY2009), the absolute level of gross non-performing loans (NPLs) for all Indian commercial banks increased by 22.5 per cent, compared with 11.9 per cent the year before.

"Although the NPL expansion must be seen in the context of the problems faced by banks globally over the past couple of years, the rapid expansion of retail lending in recent years, combined with the slowdown of the Indian economy, has led to increased delinquency rates, especially for unsecured retail loans. Concurrently, the future performance of restructured loans will determine the evolution of the NPL trend in India," says Nondas Nicolaides, Moody's lead analyst for the Indian banking system.

Indian commercial banks' profitability has been improving in recent years with core income benefiting from the high lending environment and net interest income rising sharply in FY 2009. However, in the short term, Moody's expects some of the rated entities' profits to be severely affected by the central bank's recent requirement that banks should increase their NPL provision cover ratio to at least 70 per cent by September 2010.

For the moment, though, Moody's maintains its positive stance with regard to the rated commercial banks' relatively stable core revenues and sound profitability ratios, which act as a moderately positive rating driver. Moody's contends that Indian banks need to focus on increasing their fee-based income, as this will be the key to improving their quality of earnings and maintaining future profitability. "In particular, more diversified earnings profiles will act as positive drivers for PSBs' bank financial strength ratings," adds Mr Nicolaides.

Current positive rating drivers for all the rated Indian banks, in particular the PSBs, are their robust deposit franchises, ensuring them cheap and stable sources of funding. The PSBs' comfortable liquidity profile on the back of their robust deposit base is also a positive rating driver for Moody's rated banking universe.

Moody's key concern in terms of capitalisation remains the ability of certain PSBs that are close to the 51 per cent government shareholding threshold to raise fresh capital to fund their future growth. Certain rated top-tier PSBs have openly expressed their wish for capital injections by the government, which has recently been granted a $2 billion loan package from the World Bank for this purpose.

The Indian authorities estimate that some PSBs will require injections of around US$4.8 billion during FY2010-FY2011 to maintain capital adequacy ratios of at least 12 per cent and also facilitate credit expansion in the medium term.

In terms of risk positioning, corporate governance is undergoing improvement with the ntroduction of "fit and proper" rules on appointments to boards of directors, but, overall, risk management systems are evolving and have yet to reach the quality of those of international banks.

Nonetheless, Moody's believes that Indian banks' practices are generally appropriate for the risks they take, given that regulatory limits and the banks' generally conservative risk appetites do not expose them to any high or complex risks.

Moody's assesses India as a high support country, which incorporates the history of support for banks in India, especially for PSBs. It also takes into account the willingness and ability of the central bank to resolve problems even with troubled small private sector banks, usually by merging them with larger PSBs