Moody's keeps outlook on banks stable despite weak asset quality

The capitalization at public sector banks (PSBs) will remain weak but government support may provide relief, said Moody's

Global rating agency Moody's has maintained a stable outlook on Indian banks saying that the asset quality, though weak, will be steady. The operating environment for banks is stable, supported by stable economic growth.

"Asset quality will be stable (but weak) as cleanup of legacy problem loans nears completion and corporate health improves. Banks have recognized the bulk of legacy problem loans and will start making recoveries from large resolved non-performing loans (NPLs)," Moody's said in its annual banking system outlook.

This will help shore up asset quality, although the degree of success in resolution of large NPLs will determine the extent of asset quality improvements. Also, corporates' financial health will limit new NPL formation. However, stress among NBFIs is a risk.

The capitalization at public sector banks (PSBs) will remain weak but government support may provide relief. Public sector banks will continue to grapple with weak capitalization and depend on government capital injections to meet minimum capital requirements. PSBs account for over 70 per cent of the domestic banking business.

The government support for public sector banks will remain strong. Capital infusions over the past few years for PSBs facing capital shortfalls and other government measures, provide strong support for this assumption.

Moody's said the operating environment will be stable, supported by robust economic growth. "We expect real GDP to grow 7.2% and 7.4% in the year ending March 2019 and in the following year, respectively, driven by investment growth and strong consumption", it added.

The liquidity constraints at non-bank finance institutions (NBFIs), increasingly important providers of credit for the economy, will be a drag on growth. Also, rising interest rates are a risk, it said.

Profitability will improve but remain weak due to high credit costs. Net interest margins (NIMs) will widen marginally thanks to a reduction in NPLs and a strengthening of banks' pricing power. This change comes amid woes surrounding debt capital markets, which make bank loans more attractive for corporate borrowers.

The credit costs at public sector banks will remain high despite a decline, and this will weigh on system-wide profitability, it added.