Good economic growth, favourable demographics and under-penetration is benefiting the growth of Indian banking sector and banks is the country are expected to have another good year during 2011-12, according to a report by research firm Standard & Poor's.
In its industry report card titled 'Indian banks are likely to ride an economic growth wave', S&P, however, said that inflationary pressure, rising competition and risk management practices will remain major challenges for the sector.
"We expect the sector's asset quality to improve in view of the economy's sound performance. The banks could also benefit from limited loan concentration and India's lower leverage than other Asian countries, in terms of a ratio of overall credit to GDP," S&P credit analyst Geeta Chugh said.
According to S&P, earnings pressure on the banks eased during the last fiscal, while the the introduction of a base lending rate -- which established a floor lending rate -- also boosted profitability of the sector. In addition, rising interest rates helped Indian banks, it said.
"Indian banks are benefiting from the economy's sound growth, favourable demographics, and under-penetration. But... high inflation, increased competition, and evolving risk management practices will remain key challenges," it said.
While the country grew by 8.5% last fiscal and the government expects the growth momentum to continue this year as well, over half of the country's population is below the age of 30 years and are a major target group for banks.
Besides, penetration of banking services in the country still remain low and the government has set targets to provide banking facilities to all habitations having a population of over 2,000 by March, 2012.
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The non-performing loan ratio of Indian banks was about 2.6% in 2010-11 and S&P said it expects the numbers to fall this year. To support capitalisation, the government injected Rs 23,200 crore into state-owned banks during the last three fiscals.
"We believe pressure on the banks' capital is likely to ease in FY-12 2012. The government has budgeted Rs 6,000 crore to recapitalise banks," it said.
S&P said the outlook for the sector is stable this fiscal.
"We expect the sector's asset quality to improve in view of the economy's sound performance...Overall earnings are likely to be stable as lower credit costs offset a dip in margins," it said.
There are 26 state sector banks in India, besides a number of private and cooperative sector players.