: The government’s fresh push to resolve the problem of banks’ non-performing assets through an ordinance is likely to spike their provisioning costs in the short term as they would need to take significant trimming on bad loans, Fitch Ratings said on Friday.
Further losses thanks to higher provisioning for bad loans could nudge weaker banks closer to a breach of their capital requirements and even force mergers, unless they receive ‘pre-emptive capital injections’, the ratings agency said. However, the multi-decade low bank credit growth clocked in 2016-17 is likely to remain low for a couple of years — and prove to be a silver lining, as banks will need less fresh capital till 2018-19 than estimated earlier.
Termed the greater powers assigned to the central bank to intervene in banks at ‘an earlier stage when risks build’ as an important step towards a healthy banking system in the future, Fitch said the move also makes it more likely that the number of state banks will fall in the medium term.
“Further losses at some of the weakest small- to medium-sized state banks could pressure them to shrink, or to eventually exit the system by entering into forced mergers. We expect the authorities to manage this in a way that is least disruptive for the financial system, but the process will entail risks for investors of capital securities, at least in the case of weakest banks,” said a Fitch Ratings report titled ‘Prospects for Bad Loan Clean-Up at Indian Banks Improving.’
“The resolution of non-performing loans is likely to require significant haircuts if the re-priced loans are to attract attention from private investors and asset-reconstruction companies. State banks, which hold the bulk of stressed assets, are likely to report low returns on assets for FY17 and any material recovery is likely to be delayed as resolution crystallises losses and forces a higher level of provisioning,” the agency said.
Large state banks will also face higher provisioning costs, so Fitch expects them to eventually receive more capital from the government than has already been budgeted. “However, very weak loan growth could mean that banks will require less new capital by FYE19 than we had previously estimated. Bank loan growth reached a multi-decade low of around 5% in FY17, and looks set to remain low for the next one to two years,” the report predicted.
While the influx of low-cost deposits into banks has been a net beneficial impact of demonetisation on the banking sector, Fitch has said the resulting decline in funding costs may not be enough to counter the pressures of income loss and weak growth. However, it does provide banks some more room to absorb higher provisions and lessen the impact on their capital.
Although the resolution of bad assets will face significant implementation challenges, Fitch said that the new regulations to speed up an NPA fix are the ‘logical next step to follow the asset-quality review and other measures that increased recognition of bad loans over the last two years.’
“This was important as there has been little evident progress on bad-loan resolution, while the NPL stock has continued to rise, albeit at a slowing pace. We believe this natural progression reflects stronger intent and willingness from the authorities to address the problem,” it said, adding that asset resolution is likely to strengthen over the next few years.
