Fitch Ratings on Tuesday downgraded the Viability Rating of the Punjab National Bank (PNB) to 'bb-' from 'bb' and maintained the rating on Rating Watch Negative (RWN) following a multi-crore fraud involving diamond trader Nirav Modi.
According to a Fitch statement, PNB's other ratings were unaffected by this downgrade but it expressed doubts whether the bank management would be able to address the fraud quickly.
"The downgrade follows our assessment of how losses resulting from fraudulent transactions reported in February 2018 will affect the bank's financials, including its earnings and core capitalisation. The downgrade also reflects the bank's risk controls, which we think are weaker than what we had previously believed, since the fraud was undetected for several years and acquired a large scale of $2.2 billion. That said, the bank plans to strengthen its risk control," the statement said.
Fitch said the PNB's Viability Rating reflected its weakened capitalisation and profitability due to "larger-than-Fitch-expected deficiencies in management oversight and risk controls. This is somewhat offset by its robust funding and liquidity profile stemming from its significant domestic franchise.
"Fitch is uncertain whether PNB's management will be able to address the fraud quickly, due to the involvement of various investigative agencies. A delay may affect recoveries, creating more capital demand. PNB's ability to withstand further shocks will be greatly diminished if adequate capital replenishment does not occur by way of internal or external sources," the statement said.
The fraud of around $2.2 billion in PNB, the second largest in public sector, was blamed on Nirav Modi and his uncle Mehul Choksi as well as weak banking oversight.
"The RWN reflects our belief that potential losses will largely consume the $1.6 billion of capital injected in 2H18, pressuring the bank's capital buffers over the medium term. PNB's ability to sustain, if not improve, its buffers through sources such as retained earnings, fresh equity raising and stake sales is important for its Viability Rating.
'We will resolve the RWN once we have greater clarity around the status of PNB's capital buffers and earnings trend, but this may take six months or longer," Fitch said.
It said PNB's Support Rating of '2' and Support Rating Floor of 'BBB-' remain unchanged due to the bank's high systemic importance as India's second-largest state-owned bank, which underpins the state's high propensity to provide extraordinary support to PNB.
Fitch said that losses related to the fraud will act as a drag on PNB's overall credit profile over the next year or two and will immediately increase the bank's non-performing loan (NPL) ratio and credit costs.
The regulatory requirement to provide for 100 per cent of fraud-related losses will increase provisioning requirements, it said.
Fitch expects the bank to report losses in the financial year ending in March 2018 (FY18) and most of FY19 and its gross NPL ratio to rise by at least 3 per cent of loans by FY19.
However, profitability may improve faster than expectations in FY19 if some large NPL accounts were resolved during the course of the year. Loan-loss cover may not see large deterioration given the provisioning requirements, it added.
Fitch said: "'N' upgrade of the Viability Rating is envisaged until the RWN is resolved."