Global rating agency Standard & Poor's (S&P) today said bad loans of Indian banks may increase further due to sluggishness in the economy coupled with high interest rate regime.
Banks in the world's largest developing economies of Brazil, Russia, India, and China (BRIC) could come under pressure over the next 12-24 months, S&P said in a report.
"We believe the asset quality of Indian banks is likely to deteriorate due to the moderation in economic activity, high inflation, high interest rates, and rupee depreciation," S&P credit analyst Geeta Chugh said.
She pointed out that small and midsize companies are particularly vulnerable.
"Stress is also mounting on some highly leveraged large companies (in India)," she added.
An RBI working group recently suggested higher loan-loss provisions and ultimately ending forbearance on asset classification, and recognition of these stressed assets as non-performing.
The group has recommended increasing the provision requirements on restructured loans to 5 per cent, from the current 2 per cent.
NPAs in public sector banks which dominates the Indian banking industry stood at about 3.3 per cent of the assets in 2011-12 against 2.3 per cent a year ago.
The S&P report titled 'Government Support Should Enable BRIC Banks To Ward Off Economic Headwinds' further said that a slowdown in growth in China, Brazil, and particularly India could weaken the asset quality and earnings of banks in these countries.
However, it said the BRIC banks ties with governments may improve their credit profiles.
State ownership and control of a significant part of the banking industry in BRIC countries is a critical rating factor, it said.
"Such a link is integral to the economic model of these countries. We expect governments to step in to avoid any abrupt and unexpected deterioration in local banks' financial condition. Government ownership and economic development policies link the credit ratings on the largest BRIC banks to government creditworthiness," she added.
According to the report, whereas asset quality in Brazil, China, and India is weakening, problem assets in Russia are declining from the peak of the recession despite credit risk in Russia remaining very high.
The earnings of banks in China and Brazil could decline in 2012, but remain satisfactory. Returns in India and Russia in 2012 are likely to be at levels similar to 2011, it said.
The negative outlook on the banks in India (BBB-/Negative/A-3) reflects the negative outlook on the sovereign rating.