Moody's: Indian banks' final push for NPL recognition will hurt profitability in the coming quarters

Moody's Investors Service says that the final stage of a multiyear initiative by India's central bank to push banks to recognize problem assets more accurately will reduce profitability for the sector in the near term, but produce benefits over the longer term.

"While this push will increase the already-high non-performing loan (NPL) ratios and provisioning burdens for India's banks, and strain their profitability in the near term, cleaner balance sheets in the long run will be credit positive for the sector," says Alka Anbarasu, a Moody's Vice President and Senior Analyst.

"The Reserve Bank of India's rules are credit positive because they provide a clearer, time-bound process for resolving stressed assets and will prevent a future buildup of problem loans in the system," says Anbarasu. "Also, we have already been taking into account the system's restructured assets, not just NPLs, when assessing the banks' credit profiles, so shifts in the composition of the broader asset pool will not have much bearing on our assessment of the banks' asset quality."

 

Under the new rules for bad debt resolution that the RBI implemented in March 2018, banks can no longer resort to various loan restructuring schemes to delay the recognition of NPLs.

Although banks have recognized many loans as NPLs following an extensive inspection of loan books by the RBI in 2015, they still hold large volumes of restructured loans, a large share of which will become NPLs in the coming quarters. As banks reclassify these assets, NPL ratios will gradually rise, but once this process is complete, they will stabilize and eventually decline substantially.

"Increased provisioning will hurt the banks' profitability, and weaker public sector banks in particular will continue to report losses in the next fiscal year, adding pressure on their capital ratios," says Anbarasu. "Nevertheless, the near-term impact of this profitability deterioration on their credit profiles will be largely offset by planned capital infusions from the government."

Among the rated private sector banks, ICICI Bank Limited (Baa3 stable, ba1) and AXIS Bank Limited (Baa3 stable, ba1) have the highest ratio of stressed assets but are better equipped to face higher credit costs because their profitability is superior -- and so is their capitalization as a result.

Most of the existing restructured assets are legacy loans originated in 2009-12, largely to infrastructure-related sectors, such as construction and power, and Moody's expects growth in new stressed assets to be limited.

The power sector accounts for more than half of stressed assets, as it continues to struggle with a low capacity utilization rate, with state-owned power distribution companies remaining under stress and holding off on entering into long-term purchasing agreements with electricity generators.

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