Maintaining negative outlook on the country's banking sector, Fitch Ratings today said gross bad assets of domestic banks could reach 4.2 per cent of advances this fiscal and the asset quality could remain stressed over the next year.
"There is a risk that our initial gross NPA ratio forecast of 3.75 per cent could rise to 4.2 per cent this fiscal due to a more protracted downturn, the impact of which should be felt over the next three-four quarters," Fitch said in a report.
"The stress is not yet completely visible in the reported NPAs, but is clear in the performing restructured loans," it added.
On the negative outlook for the sector, Fitch said it is closely aligned with those of the sovereign, and could be affected by any change in the sovereign rating/outlook.
On Monday, the world's largest rating agency S&P warned of a one-in-three chance of a sovereign downgrade within the next 24 months, citing bloated government finances and poor chances of an improvement in revenue generation and thus narrowing the fiscal gap, which is projected to touch 5.5 per cent this year.
Fitch also said that it believes the slowdown would be more protracted than previously envisaged, compounded by global economic weakness and domestic concerns such as a weak fiscal position and persistent inflation. It further noted that the Q2 GDP numbers are at their lowest in seven years.
About the banking system worries, it said the rising risks come primarily from concentrated exposure of banks to the infrastructure sector which could prove to be a long term challenge if structural bottlenecks are not cleared swiftly.
"The risk of asset quality deterioration is higher for medium-sized banks and is weakening their credit profiles," said the report.
The restructured assets problem is also partly cyclical, which should be largely alleviated by an economic recovery, as in previous years. However, Fitch believes that the level of slippages from restructured assets could be higher as the level of stress is higher this time around.
On the flurry of reform measures in the recent months, it said though these steps may provide the much-needed boost to investor sentiment, timely implementation is critical to put the economy back on a recovery path.
On the positive side, the report notes that the core capital of the banks is largely protected.
"The government's commitment to a minimum 8 per cent Tier 1 capital for its banks underpins the capital position of the overall banking system.