Moody's retains negative outlook on Indian banking system

Global rating agency Moody’s has retained a negative outlook on the Indian banking system due to the adverse effect of sticky loans and the challenging economic conditions.

Also, in the short term, it said, the Reserve Bank of India’s directive to banks to improve their provision cover for non-performing loans (NPLs) to 70 per cent by September 2010 could hit profits of some of the banks.

The agency had changed the outlook from stable to negative in January 2009.

While Moody’s sounded cautious on the rising level of non-performing assets, it also said that for the moment, the agency maintained a positive stance on the rated commercial banks’ relatively stable core revenues and sound profitability ratios.

The main concern about the Indian banking system was the deteriorating asset quality and the volume of restructured loans. The absolute level of gross NPLs for all Indian commercial banks increased by 22.5 per cent in 2008-09, compared with 11.9 per cent in 2007-08.

Nondas Nicolaides, Moody’s lead analyst for the Indian banks, said the NPL expansion should be seen in the context of the problems faced by banks globally.

At the same time, the rapid expansion of retail lending in recent years and the slowdown of the Indian economy has increased delinquency rates, especially for unsecured retail loans.

The future performance of restructured loans would determine the evolution of the NPL trend in India. In the third quarter of 2008-09, RBI had allowed banks to restructure loans for the second time for viable units facing temporary cash flow problems.

Indian commercial banks’ profitability has been improving in recent years, with core income benefiting from the high lending environment and net interest income rising sharply in 2008-09.

“We contend that Indian banks need to focus on increasing their fee-based income, as this will be the key to improving their quality of earnings and maintaining future profitability. In particular, more diversified earnings profiles will act as positive drivers for public sector bank’s financial strength ratings,” Moody’s said. The current positive rating drivers for the Indian banks were their robust deposit franchises, ensuring them relatively cheap and stable sources of funding.

The comfortable liquidity profile of public sector banks on the back of their robust deposit base was also a positive rating driver for Moody’s rated banking universe. Operating expenses have remained proportionally under control in recent years, with public sector players increasingly trying to rationalise staff costs to contain their expenses.