The Hindu Business Line : Asset quality may come under strain: Moody’s

Mumbai, June 25 Moody’s Investors Service has warned that Indian banking system’s asset quality could come under strain, with higher levels of non-performing loans, as a reversal of the favourable credit cycle that has underpinned robust Indian loan growth over the past few years has gradually occurred and there has been a weakening in business and corporate earnings.

Pointing out that the global de-leveraging process had caused large capital outflow from India since late 2008, the global credit rating agency said, “This has tightened the provision of credit to the real economy from the banks and raised the capital costs for corporates.”

Moody’s emphasised that certain rated Indian banks – especially in the private sector – are well capitalised and capable of absorbing the related costs of the negative credit outlook. Private sector banks have been able to raise significant amounts of fresh equity in the past few years by leveraging favourable capital market conditions, both locally and globally.

PSBs’ troubles

On the other hand, certain public sector banks (PSBs) may need fresh equity as they face both tighter Tier I capital ratios and limited ability to raise new capital, given their government shareholding levels are close to the 51 per cent threshold.

Referring to the recent statements by the government that it may consider the option of recapitalising PSBs to strengthen their financial position, Moody’s said any commitment by the government on this front would be welcome from a creditor and rating perspective. Such a development would not only raise banks’ Tier I and tangible equity ratios as well as support future loan expansion; it would also enhance their loss absorption capacity.

Profitability

The profitability ratios of India’s commercial banks, according to Moody’s, were relatively moderate, but their core recurring income and profits had climbed in recent years, implying they had been leveraging growth opportunities and enhancing earnings capacity, in turn supporting their balance sheet strength and financial muscle.

“More recent results for the fiscal year ended March 2009 indicate that the profitability of banks’ has come under some pressure through higher credit costs, although the situation has been alleviated by investment gains – in a declining interest rate environment – on their sizeable government securities portfolios. Moreover, a focus on increasing fee-based income, especially by public sector banks, is key to improving earnings quality and maintaining future profitability,” the agency said.

Deposit base

A positive and important rating driver for all the rated Indian banks, in particular the PSBs, the rating agency felt, was their robust deposit franchisees, which assure them of a relatively cheap and stable source of funding and a comfortable liquidity profile. This means that Indian banks have little to no dependence on wholesale funding, with no repercussions on margins from the possible roll-overs – at much higher cost in the current credit environment – of any outstanding debt.

In terms of efficiency, Indian commercial banks boast of a cost-to-income ratio of around 50 per cent, a figure that compares favourably with the ratios of other international banks.

Moody’s has assessed India as a high support country, based on a strong track record of support provided to commercial banks by the authorities, especially to majority government-owned banks. Even small private sector banks have enjoyed a high level of support in recent years as they have usually been bailed out through mergers with larger PSBs.

The credit rating agency recently placed the local currency deposit ratings of all Indian banks rated by it on review for possible downgrade.

The review will look at the extent to which India’s ability to provide support to its banking system, if needed, is converging with the government’s own debt capacity as a result of the ongoing economic and credit crisis.

Ratings, according to the report, could go up when the successful and full implementation of PSBs technology plans and modernisation efforts start yielding results; a significant improvement occurs in structural profitability through cost rationalisation and containment of non-performing loans; and further development of fee-based income that improves earnings quality.

Ratings could go down if there is a significant deterioration in asset quality and weakening of provisioning levels that impair the banks’ underlying financial health; declining Tier I capital ratio with limited prospects of being replenished; and additional pressure on PSBs’ franchises and market positions.

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More Stories on : Non-Performing Assets | Credit Rating | Financial Markets

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