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The increased provisioning for restructured loans is credit positive for Indian banks as it increases their loss-absorption buffers, Moody's today said.
Last week, the RBI finalised guidelines that will require banks to raise their provisions on restructured loans to 5% from 2.75% currently.
"The higher provisioning is credit positive for India's banks because it increases their loss-absorption buffers and incentivizes them to enhance their underwriting standards to reduce credit costs," Moody's said in a statement.
The RBI began applying the provisioning guidance on new restructured loans on 1 June, but has opted to phase in implementation on existing restructured loans, with provisioning set at 3.50% by March 31, 2014, 4.25% by March 31, 2015 and 5% by March 31, 2016.
"In our view, the authorities' focus on provisioning guidelines for restructured loans reflects a more proactive management of the asset cycle," it said.
Indian banks' restructured loans have increased in the past two years, and 15-25% of restructured loans eventually slip into non-performing loan (NPL) classification within 12 months of restructuring, it said.
The RBI's increased emphasis on restructured loans is also seen in the more stringent treatment of these loans in upcoming revisions to the loan classification system, it said.
Specifically, it said starting April 2015, a standard performing loan would immediately be classified as substandard upon restructuring, and cannot revert back to standard status.
The new guidance contrasts to current practice, which allows banks to reclassify a restructured loan as a standard performing loan when certain conditions are met, it added.
The RBI also decided that short-term loans (except for working capital) that have been rolled over more than twice would be treated as a restructured loan, it said.
We expect the new guidance to affect most public-sector banks, particularly those with high levels of restructured loans, it added.
Private-sector banks will be less affected. While we expect higher provisions to pressure banks' profitability in coming quarters, it said "we expect the banks' strong loss-absorption buffers and balance sheets to more than offset any pressure on profitability."
