Good performance masks problem assets for Indian banks, says S&P

Tough for banks to keep NPA levels low in future

The forbearance – moratorium on repayments for six months-- is masking problem assets for Indian banks arising out of Covid-19. Financial institutions, including banks, are likely to have trouble maintaining momentum after the proportion of non-performing loans (NPL) to total loans declined consistently in 2020, according to Standard and Poor’s (S&P).

Rating agency S&P, in a statement, said while financial institutions performed better than we expected in the second quarter, much of this is due to the six-month loan moratorium, as well as a Supreme Court ruling barring banks from classifying any borrower as a non-performing asset. It released a report "The Stress Fractures In Indian Financial Institutions."

The loan repayment moratorium ended on August 31, 2020. The non-performing loans in the banking sector will likely shoot up to 10-11 per cent of gross loans in the next 12-18 months, from 8 per cent on June 30, 2020.

“We forecast the banking system's credit costs will remain elevated at 2.2-2.9 per cent this year and next, in line with our expectation of elevated credit cost for many other countries in the Asia-Pacific”, the rating agency said. S&P measures credit costs as annualised loan loss provisions as a percentage of gross loans.

Resumption of economic activity, government credit guarantees for small to mid-size enterprises, and buoyant liquidity is helping limit stress. “Our NPL estimates are lower than earlier, but we are still of the view that the sector's financial strength will not materially recover until fiscal 2023 (ended March 31, 2023).

The agency said 3%-8% of loans could get restructured. “At this juncture, we believe that the system restructuring could be at the lower end of our estimates”, it said.

Banks and non-banking financial companies (NBFCs) have also been strengthening their balance sheets and bolstering their equity bases. Banks have also been building reserves and creating excess Covid provisions, which should help them soften he hit from Covid-related losses.

For NBFCs, performance has been improving. Like with banks, collections have surged for NBFCs. Top-tier NBFCs are benefiting from surplus system liquidity, as indicated by a sharp reduction in risk premiums. Weaker finance companies, however, have faced higher risk premiums. Such polarisation is expected to persist in 2021, it added.