Moody's maintains negative outlook on Indian banks

Says current practices mask banks' NPA, capital challenges

Moody's today said it continues to maintain its negative outlook on the Indian banking system as asset quality is likely to weaken further in the current uncertain macro-economic environment creating further stress on banks' profitability.

"Our outlook is negative for the Indian banking system, as it has been since November 2011, reflecting the challenging nature of an operating environment that is characterised by slow economic growth, high inflation, high interest rates, and a weak local currency," Moody's analysts said in a report released today.

"We expect these factors to lead to a further deterioration in asset quality, an increase in provisioning costs, and a fall in profitability," they added.

The rating agency had last revised its outlook on the Indian banking system to negative from stable in November 2011.

It considers the loan classification (particularly the restructured loans) and provisioning practices in India to be weak as they mask the extent of banks' asset quality and capital challenges.

"When we adjust for these, we find that many banks' impaired asset levels are at or close to the assumptions we use under our adverse scenario for stress testing purposes," the analysts said.

The analysts expect difficult operating environment to expand gross non-performing assets and restructured loan portfolios of domestic banks in coming quarters.

However, Moody's agreed that the strong business franchises of Indian banks that support their low-cost funding profiles helps the lenders maintain sizeable lending margins to sustain pre-provision 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," the analysts said.