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The financial performance of Indian banks has continued to improve in the past few years and it bodes well for the sector’s intrinsic risk profiles, according to global rating agency Fitch Ratings. The rate of improvement in terms of asset quality and profitability has exceeded Fitch’s expectations. The rating agency added that capital buffers are in line with its estimates.
The rating agency noted that the Indian banking sector’s impaired-loan ratio fell to 4.5% in 9MFY23 compared with 6% in FY22. The decline in impaired-loan ratio was attributed to higher loan growth along with lower slippages and improved recoveries.
Though the rating agency expects a further improvement in sector’s performance by the end of FY23, banks are likely to face the risk of asset-quality pressure associated with the unwinding of loan forbearance in FY24. Meanwhile, the sector’s provision cover has improved from 71% in FY22 to 75% during 9MFY23. It added that Indian private banks are significantly better placed than state-owned banks due to their lower impaired loan ratio of 2.1%, against state-owned banks’ 5.6%.
Fitch Ratings said that according to its projections, the country’s strong economic momentum has helped credit cost to drop to 0.95% during the 9MFY23 from 1.26% in FY22.The rating agency further said that lower credit cost has helped in improving return on assets to 1.1% in 9MFY23, compared to Fitch’s FY23 estimates of 0.9%. In addition, the sector’s earnings have also benefited from higher-than-expected loan growth and improving net interest margins.
The rating agency pointed out that the overall banking sector’s common equity Tier 1 (CET1) ratio rose by around 54 bps to 13.3% during 9MFY23, alongside a 460bp drop in the net impaired loans/equity ratio to 9.6%. This drop indicates that the risks to capital were easing, but government-owned banks’ CET1 ratio stood at 11.5%, which could be more at risk in a downside scenario. Further, state-owned banks had limited equity raising capacity, preferred hybrid capital instruments and were dependent on government recapitalisation. Meanwhile, the private banks’ CET1 ratio was significantly higher at 16.3% and they also demonstrated better access to the equity capital market.
Fitch Ratings expects there is an more scope for an upside in banks’ performance and it could persist for longer than the rating agency had initially expected. The rating agency said that the pandemic-related risks were largely in the background and the banks’ balance sheet has strengthened over the past three years, in part due to forbearance.
The rating agency added that the sustained easing of financial-sector risks could support a higher operating environment score, but this will depend on the agency’s assessment of various factors, such as medium-term growth potential, borrower health and loans under regulatory relief. Nonetheless, there is also a risk that continued strong loan growth may lead to selective or incremental increases in risk appetite, while net interest margin compression and higher credit costs post easing of regulatory forbearance could still weigh on sector’s financial health.