In the current negative economic scenario, credit rating agency Moody’s has done the expected: it has downgraded the outlook for Indian banks, indicating volatility and uncertain conditions in the coming 12 to 18 months. On the other hand, the other leading agency, Standard and Poor’s (S&P), has indicated a stable outlook for Indian banks. S&P has also simultaneously changed the way it calculates country risk, clarifying that the resultant upgrade by a notch for India should not be seen as a rating upgrade. When leading agencies differ in their assessment, it is customary for the market to go by the lower rating. Credit rating agencies must tread with caution in view of their need to live down the reputation acquired from their inability to anticipate events right from the Asian meltdown of the late 1990s to the recent global financial crisis in 2008. In fact, the latter, which originated from the subprime crisis in the US, was partially caused by imaginative triple-A ratings given to hybrid financial products.
But this does not mean that the latest negative signal sent out by Moody’s is uncalled for. The Indian banking sector is facing multiple adverse factors both domestically and internationally. However, S&P is also right in seeing banking regulation in India to be in line with international standards. As rational as Moody’s downgrade is, there is little need for alarm. HDFC Chairman Deepak Parekh has asserted that the Indian banking system is not at risk and is safe as well as robust. It is during times of crisis that major state ownership and regulatory conservatism emerge as comfort factors. The bane of western banking, fat bonuses even in times of trouble, is unknown in India.
Much of the overall sentiment regarding the condition of Indian banking is driven by the state of the largest commercial bank, State Bank of India (SBI). The industry downgrade came even as the market discounted the improved bottom line in the bank’s second quarter results. This is because provisioning has not kept pace with the rise in non-performing assets, leading to a fall in overall coverage. Recently, the bank itself was downgraded on account of, among other things, its unsatisfactory capital adequacy. For both these conditions the bank has been poorly served by its majority owner, the government. It has so far been unable to provide the much-needed additional capital and in the recent past sent wrong signals regarding performance. The new leadership at the bank began by cleaning up the balance sheet and increasing provisioning. But this did not find favour with the Union finance ministry, which took it to task for underperformance. The bank’s management appears to be caught between the need to please both the regulator and the owner. While the government has to do its job, the bank must also go the extra mile in keeping a watchful eye over its asset quality. It is fortunate in not having excessive exposure to the troubled electricity sector and in continuing to enjoy high access to cheap deposits. How SBI conducts itself will partially determine the outlook for the Indian banking industry.