How India should see Moody's forecast on its banking sector

In its recently-released report on India's banks, titled Banking System Outlook - India: Gradual Improvement in Operating Environment Drives Stable Outlook, Moody's Investors Services concluded that India's banking system is moving past the worst of its asset quality slump.

It rates 15 banks in India that together account for around 70 per cent of system assets. Four are private-sector banks and the remaining 11 public sector banks. The PSU banks are owned by the government.

The four private-sector banks exhibit an average baseline credit assessment (BCA) of baa3; in line with their supported ratings and India's sovereign rating of baa3. By contrast, the PSU banks exhibit weaker standalone fundamentals and BCAs as low as b3.

However, asset quality will remain a negative driver of the credit profiles of the highest-rated Indian banks. While the asset quality is still bad, the worse is already over, according to the report.

However, the ratings agency said that capital levels in state-run banks remained a key weakness for government-owned entities. Indian government's pledge to provide state-run banks with Rs 70,000 crore by March 2019 is less than its estimated requirement of Rs 1.2 lakh crore.

A potential way to bridge this capital shortfall would be to slow loan growth to the low single digits over the next three years, the report said. It added that the state-run entities will require the capital with limited access to capital markets, while private banks will benefit from solid capitalisation and good profitability.

The stock of impaired loans may still increase looking at the figures Indian banks have disclosed; there has been a 96 per cent spike in non-performing assets to Rs 6,29,774 crore in June 2016 from Rs 3,20,553 crore during the same month last year.

The percentage of gross bad loans out of the total loans of Indian banks has doubled to 8.7 per cent in June from 4.6 per cent in March last year. However, the RBI has not relaxed its claws over NPAs in banks.

But the rating agency believes that the asset quality slump will deepen in the near future. The outlook is based on sound reasons. The major factors accounting for the growth of the banking industry are a good operating environment, and a stabilising economy with many bright spots.

A headline GDP growth of 7.5 per cent plus is predicted for the next two years ahead compared to the 7.3 per cent in 2015. The key drivers for the spurt in growth and a stabilising trend are the favourable monsoon season, ongoing public investment and sustained increase in levels of Foreign Direct Investment (FDI).

However, according to them, the asset quality is yet to improve, but the picture gets better on account of an economic reform phase that the industry and the country as a whole are undergoing.

Moody's says the Indian government will continue to provide a high level of support to the banks. For the PSU banks in particular, it expects that the government will not make any changes that could suggest the possibility of reduced support to or differentiation among the banks, because doing so could entail significant systemic risks.

As per Moody's, the horizon of the Indian banking industry is widening with economic opportunities in the country attracting investment from within and outside. It is, in fact, the silver lining with bright spots of tax reforms, and fiscal and monetary measures in sight already.