Moody's maintains negative outlook on banking system

Says Indian banks mask extent of their asset quality and capital challenges

Moody’s on Tuesday said it continued to maintain a negative outlook on the Indian banking system, as asset quality was likely to weaken further in the current uncertain macro economic environment creating further stress on banks’ profitability.

The rating agency also considers the practices here on loan classification (particularly on restructured assets) and provisioning practices to be weak. It believes banks mask the extent of their asset quality and capital challenges.

Moody’s has kept its outlook on the Indian banking system unchanged since November 2011, when it revised this to negative from stable. “This environment is characterised by slow economic growth, high inflation, high interest rates, and a weak local currency, and we expect these factors to lead to a further deterioration in asset quality, an increase in provisioning costs and a fall in profitability,” said a statement from Vineet Gupta, a vice-president and senior analyst at Moody’s.

The agency said it expected a difficult operating environment to expand gross non-performing assets and restructured loan portfolios of domestic banks in the coming quarters. Gupta added some of the banks would need to raise additional money to strengthen their capital base.

“When we also consider the high level of loan growth which, at about 15 per cent annually, is expected to continue outstripping internal capital generation, then most of Moody’s rated Indian banks will be challenged to maintain capitalisation levels at current levels, and some will even need to raise new capital externally,” said Gupta. The agency, however, believes the government will provide “extraordinary support” in the form of unsecured loans and capital injections to both public and private sector banks.

It also agreed that the strong business franchises of Indian banks that support their low-cost funding profiles help the lenders maintain sizable lending margins to sustain pre-provisioning earnings. “We expect a slowdown in lending income because of the deteriorating nature of the operating environment, although the banks’ current wide lending margins (net interest margins of 300 basis points) will allow for steady pre-provision incomes as a percentage of average risk-weighted assets,” it said.

Moody’s currently rates 15 Indian banks, 11 state-owned and four private banks, that together had 66 per cent of the sector’s total assets at the end of March 2012.