Moody’s upgrades banking system outlook to ‘stable’

Besides receding asset quality concerns since the onset of the pandemic, declining credit costs as a result of improving asset quality is expected to result in higher profitability. Also, capital will remain above pre-pandemic levels, the global rating firm said.

Moody’s expects India’s economy to continue to recover in the next 12-18 months, with GDP growing 9.3% in the fiscal year ending March 2022 and 7.9% in the following year. “The pickup in economic activity will drive credit growth, which we expect to be 10%-13% annually. Weak corporate financials and funding constraints at finance companies have been key negative factors for banks but these risks have receded,” Moody’s report said.

Moody’s rates 11 commercial banks in India including five public sector banks which together account for around 71% of deposits in the system.

The deterioration of asset quality since the onset of the pandemic has been more moderate than it expected despite relatively limited regulatory support for borrowers. The quality of corporate loans has improved, indicating that banks have recognized and provisioned for all legacy problem loans in this segment.

The quality of retail loans has deteriorated, but to a limited degree because large-scale job losses have not occurred. We expect asset quality will further improve, leading to decline in credit costs, as economic activity normalizes, Moody’s said.

Banks’ returns on assets will rise as credit costs will decline while banks’ core profitability will be stable. If interest rates rise, net interest margins will increase, but it will also lead to mark-to-market losses on banks’ large holdings of government securities.

Capital ratios have risen across rated banks in the past year because most have issued new shares. Public sector banks’ ability to raise equity capital from the market is particularly credit positive because it reduces their dependence on the government for capital. However, further increases in capital will be limited because banks will use most of retained earnings to support an acceleration of loan growth, Moody’s said. “We continue to assume that the government will provide a very high level of support for rated public sector banks, given their strong links to the government”.