Moody's says banks' profitability may grow but risks persist

Banks’ profitability is expected to grow in the coming quarters due to benign operating environment, but high inflation and probability of formation of asset bubbles are some of the downside risks, according to Moody’s Investors Services report.

“Net interest margins are likely to benefit from India’s currently rising interest rate environment, reflecting positively on Indian banks’ profitability indicators. Potential downside risks emanate from still high levels of inflation in India,” Moody’s report said.

“We also see risks of an overheating economy, including the probable formation of asset bubbles, given our expectation of continued strong economic and credit growth, while real estate prices in metropolitan areas and equity markets have already recaptured their pre-crisis peaks,” the report said.

However, the rating agency has maintained its stable outlook on Indian banks due to strong capital levels, higher retail deposit funding, sound liquidity conditions and accelerating pace of loan growth. It expects banks to achieve loan growth of 20 per cent and deposit growth of 17 per cent for the current financial year.

Moody’s expects Indian banks to grow at an compounded annual rate of 20 per cent for the next three years.

The asset quality is also expected to improve in 2011 because industrial companies will return to utilising their full capacity. The report also said the asset quality had deteriorated since the last two years due to reduced demand from the Indian exporter and higher delinquencies on unsecured personal loans.

“Importantly, we expect loans that were restructured during the past two years to perform relatively well, as their track record so far suggests minimal slippages into problematic status,” the report said. Moody’s has also maintained its rating on debt and deposit for large Indian banks on the view that government’s capital infusion in state-owned banks provides strength and support for improving banks’ credit profile.