Improved Operating Environment for Indian Banks Noted by Fitch Ratings Amid Pandemic Recovery

Fitch Ratings

The operational landscape for Indian banks has demonstrated resilience as the economic uncertainties stemming from the Covid-19 pandemic have waned, as per an assessment by Fitch Ratings.

The sector has displayed favorable movement across several prudential indicators, showcasing an improved stance compared to the period preceding the pandemic. However, Fitch underscores the significance of maintaining appropriate cushions to mitigate potential stress, especially in light of growing risk appetite in a relatively stable operating environment.

In March 2020, Fitch had adjusted its mid-point score for the Indian banks’ operating environment from ‘bb+’ to ‘bb’, in recognition of the anticipated pandemic-induced exacerbation of prevailing stress factors in the sector. The recent evaluation, however, reveals that while India bore the brunt of the pandemic, the associated risks have now considerably subsided.

The credit rating agency highlights the enduring benefits of India’s diversified economic structure, which serves to minimize banks’ susceptibility to shocks emanating from specific sectors. Additionally, the country’s robust economy and favorable demographic trends position banks to capitalize on profitable ventures while spreading risk and revenue.

Fitch anticipates that the banking sector will profit from the ongoing formalization of the Small and Medium-sized Enterprise (SME) sector. Initiatives like the Goods and Services Tax (GST) and rapid digitization, including payment systems, are expected to bolster the provision of services at acceptable risk levels to this substantial market segment.

While there have been regulatory developments since Fitch’s recalibration of the operating environment score in 2020, the outcomes have been mixed. The Reserve Bank of India (RBI) has taken steps to bolster norms, augment governance, enhance board oversight, and address stress factors. For instance, guidelines for compliance functions and audit rules were revised in 2020 and 2021 respectively.

The RBI has also announced plans to implement expected credit loss provisioning in FY24, aligning with IFRS9 accounting standards. However, the application of IFRS9 for banks has faced delays, although it was introduced for non-bank finance companies in FY19.

Fitch highlights that the broad-based forbearance measures introduced during the pandemic obscured the true state of banks’ asset quality. Structural issues persist in the banking landscape, with India’s lengthy legal processes posing a significant hurdle to an effective bankruptcy and resolution framework. Furthermore, the ‘bad bank’ established in July 2021 has yet to make a substantial impact.

Commenting on the surge in Indian banks’ loan growth, reaching 15.4 percent in FY23, the highest since FY13, Fitch attributes this in part to pent-up credit demand following the pandemic, alongside improved growth capacity, particularly among private-sector banks. However, the rapid expansion of loans and increased exposure to specific asset classes might reflect heightened risk appetite, potentially raising sectoral risks if not carefully managed.

In terms of India’s private credit to GDP ratio, which stood at around 57 percent in 2022, Fitch notes that it moderately surpasses the median for sovereigns in the ‘BBB’ category, which is 50 percent.

Fitch, having affirmed India’s sovereign rating at ‘BBB-/Stable’ in May, predicts an average annual real GDP growth of 6.4 percent for the three years ending March 2026 (FY23-FY25), positioning India among the fastest-growing sovereigns in its rated portfolio.

Furthermore, the credit assessment agency notes that the easing of pandemic-related risks coincides with the reinforcement of capital buffers. The average common equity Tier 1 (CET1) capital ratio for the sector reached 13.4 percent by FY23, a notable increase from 10.4 percent in FY18. This has been partly attributed to approximately $50 billion in cumulative fresh equity injection by the sovereign into state-owned banks since 2015.

Fitch’s estimates suggest that earnings buffers are substantial, with operating profits constituting about 2.8 percent of risk-weighted assets in FY23, up from 0.6 percent in FY20.

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