Moody’s Investors Service has revised upward its outlook for the Indian banking system to stable from negative, citing improvement in capital base and stabilising asset quality.
In its outlook report on the Indian banking sector released on Tuesday, the global rating agency expected the country’s economy to continue to recover in the next 12-18 months, with GDP growing 9.3% in FY22 and 7.9% in the following year. Moody’s forecast that the pickup in economic activity will ultimately drive credit growth, likely to be 10%-13% annually, substantially higher than the current pace. According to the RBI data, non-food bank credit growth stood at 6.7% in August, compared with 5.5% a year earlier.
Earlier this month, Moody’s revised up its outlook for India to “stable” from “negative” after almost two years, although it retained the sovereign rating at the lowest investment grade of Baa3.
Weak corporate financials and funding constraints at finance companies have been key negative factors for banks, but these risks have receded, the agency said.
“The deterioration of asset quality since the onset of the coronavirus pandemic has been moderate, and an improving operating environment will support asset quality. Declining credit costs as a result of improving asset quality will lead to improvements in profitability. Capital will remain above pre-pandemic levels,” the agency said.
The quality of corporate loans has improved, indicating that banks have recognised and provided for all legacy problem loans in this segment, Moody’s said. “The quality of retail loans has deteriorated, but to a limited degree because large-scale job losses have not occurred. We expect asset quality will further improve, leading to decline in credit costs, as economic activity normalises,” it added.
It also pointed out the fact that capital ratios have risen across rated banks in the past year because most have issued new shares. Public sector banks’ ability to raise equity capital from the market is particularly credit positive because it reduces their dependence on the government for capital. “However, further increases in capital will be limited because banks will use most of retained earnings to support an acceleration of loan growth,” it said.
The agency expects banks’ profitability to improve because their returns on assets will rise with a drop in credit costs. “If interest rates rise, net interest margins will increase, but it will also lead to mark-to-market losses on banks’ large holdings of government securities,” the agency said. It also forecast that government support to its banks will remain strong.