Moody's: Weak corporate financial health affecting Indian public sector banks' asset quality

Moody's Investors Service says the asset quality of Indian public-sector banks will continue to be burdened by weak corporate financial health.

Asset quality deterioration among public sector banks -- one of the most important factors driving the negative outlook of India's (Baa3 stable) banking sector -- may have reached a bottom. However, the recovery in corporate credit quality is expected to be a slow multi-year process and, meanwhile, the lagging recognition of credit costs associated to non-performing loan will continue to act as a drag on the banks' credit quality.

"We expect net new nonperforming loan (NPL) formation rates for public-sector banks to be lower than those observed over the last three years, while the impaired loan ratio may stabilize at current levels," says Srikanth Vadlamani, a Moody's Vice President and Senior Analyst.

 

"An improvement in the banks' operating environment is driving this expectation," says Vadlamani.

Any improvement in asset quality will be U-shaped rather than V-shaped, according to Moody's, with only a gradual decline in the new NPL formation rates over the next two years.

First, Moody's expects the proportion of standard restructured loans becoming NPLs to continue to be much higher than historical averages, at 25%-30%.

Second, the health of corporates in India, while having stabilized, continues to be fragile on an absolute basis with high debt levels and weak debt-servicing metrics. This is particualrly relevant for public sector banks, which have a higher share of corporate loans in their loan books than private sector banks.

Moody's expects Indian corporates will increase their deleveraging efforts as conducive market conditions make it easier to raise equity and sell assets. However, despite the favorable market conditions, it will take at least 2-3 years for a meaningful reduction in leverage owing to the high debt levels.

As a result of these asset quality trends, Moody's in turn expects public sector banks to continue to have a high level of credit costs. This will constrain their internal capital generation and make them dependent on external capital infusion to increase their low capital levels.

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