Have the banking sector's losses bottomed out?

While gross non-performing assets (NPAs) of the Indian banking system are expected to rise further in this financial year, the pace of deterioration is likely to moderate, as banks, prodded by the Reserve Bank of India (RBI), were aggressive in recognising bad loans in FY16.

According to a new report by India Ratings and Research, fresh slippages to the non-performing loans category are likely to be a minimum of 1.5 per cent of total bank credit in the current financial year. In large part, these slippages will come from loans turning out in the Infrastructure and construction sectors, followed by the power sector. But, it is possible that actual slippages may turn out to be higher if companies find it difficult to service loans that were restructured in the earlier financial years. At the end of FY16, gross NPAs in the banking system stood at 7.2 per cent. (After asset quality review)

Banks' credit costs are likely to remain high, compared to the previous financial year, although these are expected to moderate. Credit costs are expected to drop to 170-180 basis points in 2016-17, as compared to 280 basis points for 2015-16, says India Ratings.

But, unlike the previous financial year, where recognition of bad loans led to higher costs, this time the increase will largely come from problems with servicing loans that have already turned bad. If companies fail to meet their interest obligations, existing loans in the substandard category are likely to be transferred to the doubtful category, where banks will have to provide higher provisioning. This will raise banks' credit costs, eating into profitability.

Ship-building followed by infrastructure and construction, iron and steel, power and textiles continue to be the most leveraged sectors among the companies analysed in the report, though the textiles sector has the highest interest coverage ratio, suggesting it is better placed to finance its interest obligations, as compared to the other sectors.