Stressed asset ratio peaked in FY15: Fitch

The worst might be over for banks in terms of stressed assets. However, the pressure on asset quality might not subside any time soon, a report by rating agency Fitch said. Gross non-performing loans for banks have registered an uptick but the accretion rate is easing, the report added.

Along with worsening asset quality, banks were also burdened with weak credit demand in the last financial year. Public sector banks (PSBs) were particularly hit by falling profitability and weakened capitalisation, the report said.

"System-wide loan growth, at 9.7 per cent, was the lowest over the past decade, and concentrated mainly in retail and farm credit. The system NPL (non-performing loan) ratio rose to 4.6 per cent of total assets from 4.1 per cent in FY14, though the bulk of the deterioration was accounted for by restructured loans, as expected. Consequently, the broader stressed-assets ratio (which includes performing restructured loans) spiked to 11.1 per cent, from 10 per cent," said the report.

However, the worst would be over for banks as the outlook for this financial year looks better, on account of a more favourable economic environment.

"The system-wide stressed-assets ratio is likely to begin falling against the backdrop of a more favourable economic environment. Gross NPL accretion has already shown signs of deceleration, and we forecast GDP (gross domestic product) growth to gain momentum and rise to 7.8 per cent. This should also be positive for credit growth as interest rates come down - given what has been surprisingly weak demand for credit," added the report.

Capital needs are also likely to increase substantially each year until 2018-19, it said, adding there are few indications of a meaningful recovery in earnings in the short term. With the capital buffers consequently deteriorating due to a growth in bad loans and low provisioning, PSBs have been tapping local markets to raise capital. As a result, the Tier-1 capital adequacy ratio improved to 9.7 per cent up from 9.3 per cent in FY14. On the other hand, the gap between the Tier-1 ratios of private banks and PSBs widened to 440 basis points.

Considering that the internal capital generation for banks remains weak along with a low equity market capitalisation and migration to Basel-III capital adequacy norms would mean that banks will have to rely on external capital.

"The domestic market for hybrid capital lacks depth and liquidity, and so banks may have little choice but to seek funds overseas as the pressure for capital builds with banks approaching the Basel-III deadline of FY19," added the report.