Indian banks will face heat of second Covid wave in H1 of FY22: S&P

Weak loans to stay elevated 11-12% for next 12-18 months

Indian banks face systemic risks as the country wades through the aftermath of the Covid second wave. The banking sector's weak loans are likely to remain elevated at 11-12 per cent of gross loans in the next 12-18 months, according to Standard and Poor's (S&P).

The second wave will impair the performance of Indian financial institutions in the first half of fiscal 2022, with much resting on the effectiveness of government measures to address this problem.

Credit losses should remain high at 2.2 per cent before recovering to 1.8 per cent in the year ending March 2023. Lenders struggled with a high level of weak loans well before the pandemic struck and, conditions have clearly deteriorated, the rating agency said.

The second wave has front-ended weakness in asset quality. Financial institutions face a strained first half amid weak collections and poor disbursements, said S&P's credit analyst Deepali Seth Chhabria.

Disbursements slowed considerably in April and May. The credit that banks extended fell by about one per cent in the first two months of this fiscal year. The drop was largely seasonal--there were similar declines in the same period for fiscals 2018 and 2019. The credit growth in India started improving in June, and will continue to do so.

The strains on finance companies can go beyond this seasonal effect. For example, Bajaj Finance Ltd. in its mid-quarter update said sales volumes for its consumer durables and auto finance businesses in May were just 40 per cent of what the management expected.

The collection efficiency for a number of finance companies fell by up to 5-15 per cent in April and May, largely due to lockdowns. Lenders catering to prime borrowers were generally less affected. SME borrowers, which make up about 17 per cent of total loans, and low-income households have been most affected.

Tourism and recreation related sectors, commercial real estate, and unsecured retail loans may contribute to higher non-performing loans (NPLs). However, the banking system's exposure to many of these segments is moderate, and should have only a limited effect.

Housing finance (excluding affordable housing) and gold loans will likely be less affected than financing for micro enterprises or commercial vehicles. Finance companies will likely be more impacted than banks, the rating agency added.