Indian NBFI Liquidity Constraint, Rising Rates Pose Risk but Bank Outlook Stable

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Outlook for the banking system in India (Baa2 stable) over the next 12-18 months is stable, said Moody's Investors Service on Monday.

The stable outlook is based on Moody's assessment of six drivers, all of which Moody's assesses at stable.

The six drivers are: operating environment; asset quality, capital; funding and liquidity; profitability and efficiency; and government support.

With the operating environment, Moody's said that the environment will stay stable, supported by robust economic growth.

Moody's expects that real GDP in India will grow 7.2% in the year ending March 2019 and 7.4% in the following year, driven by investment growth and strong consumption.

Asset quality weak but stable

However, the rating agency pointed out that liquidity constraints at non-bank finance institutions (NBFIs) — increasingly important providers of credit for the economy — will prove a drag on growth.

Rising interest rates also represent a risk, Moody’s added.

On asset quality, Moody's said that this factor will remain stable but weak, as the clean-up of legacy problem loans nears completion and corporate health improves.

In particular, the banks have recognized the bulk of legacy problem loans and will start making recoveries from large resolved nonperforming loans (NPLs), Moody’s added.

This will help shore up asset quality, although the degree of success in the resolution of large NPLs will determine the extent of asset quality improvements, Srikanth Vadlamani, a Moody's VP and senior credit officer pointed out.

Public banks: Weak capitalization remains

As for public sector banks, they will continue to show weak capitalization, and depend on government capital injections to meet minimum capital requirements, according to the rating agency.

The banks' funding and liquidity will stay strong, said Vadlamani, adding that Indian banks are largely deposit funded and their liquidity coverage ratios are all above 100%.

The funding and liquidity profiles of public sector banks, in particular, will remain resilient, despite their solvency challenges, according to Moody’s.

The banks' profitability will improve but stay weak, because of high credit costs, the firm said.

“Specifically, their net interest margins will widen marginally because of a reduction in NPLs and a strengthening of their pricing power, amid the situation in the debt capital markets, which make bank loans more attractive for corporate borrowers,” Vadlamani noted.

However, while credit costs at public sector banks have fallen, such costs will remain high and weigh on system wide profitability, he pointed out.

With government support, Moody's said that government support for public sector banks will stay strong.

Capital infusions over the past few years for all public sector banks facing capital shortfalls, as well as other government measures, provide strong support for Moody's assumption of very strong government support for public sector banks, the rating agency observed.

Moody's rates 16 banks in India, 15 commercial and one policy bank.

The 15 commercial banks account for about 70% of assets in the system. Of the 15, 11 are state-owned, with weaker standalone fundamentals than private sector banks.

The Indian policy bank that Moody's rates is the Export-Import Bank of India, with ratings on par with that of the Government of India.