Asset quality and funding risks for Indian banks rising: Fitch

The central bank's recent rate cuts are unlikely to ease asset-quality pressures to any great extent or help Indian banks correct their funding imbalances.

According to Fitch Ratings, the banks' latest results show a continued decline in overall asset quality as the economic downturn persists.

The infrastructure sector is likely to be the biggest risk for Indian banks in the year ending March 2014, putting pressure on asset quality and exacerbating structural funding mismatches.

The pace of infrastructure restructuring is likely to accelerate, as the start dates of projects under construction are delayed over the next 18 months.

Infrastructure (including power and telecom) accounted for around 23 per cent of corporate debt restructurings at end-March 2013, up from 20.5 per cent a year ago.

Lending to the sector has been aggressive since FY08; and despite some moderation in FY13, it represents the largest single-sector concentration for Indian banks.

We believe that key structural impediments - such as the availability of fuel, rising input costs and government clearances - will be hard to resolve in the short term despite recent government initiatives to tackle them.

However, the outlook could improve in the medium term if some recently announced policies are effective.

In the meantime, Fitch says it expects restructured loans to keep rising faster than non-performing loans (NPL) and assets. It said the pace of NPL accretion is slowing, thanks to the central bank's cumulative monetary easing in FY13.

It said in a statement, "However, the central bank's concerns about inflationary pressures and the twin-deficit means there is limited scope for further monetary easing after Friday's 25 bp rate cut."

It notes a slower-than-expected recovery could cause NPL growth to pick up again. We estimate gross NPLs will approach 4.2 per cent for FY13 and 4.4 per cent in FY14 as bad loans start to level off, with very gradual easing of cyclical pressures.

"The long-term nature of infrastructure assets leaves banks more exposed to asset / liability mismatches, particularly as deposit-gathering has not kept pace with credit growth," Fitch said.

The persistent negative real interest rates have channelled domestic savings into alternative investments, and the banking system loans-to-deposit ratio has risen to 78 per cent in March from 72 per cent at FYE10.

We believe that reliance on costly short-term funding, such as certificates of deposit and bulk deposits, will remain high. This dependence raises refinancing risks and the volatility of funding costs, although stable customer deposits still account for a significant proportion of the system's total funding.

Small- and medium-sized Indian banks with concentrated regional profiles and limited deposit franchises are likely be most at risk if stress levels increase.

However, most large banks, with diversified loan portfolios and better funding profiles, should be able to absorb stress through profits alone, though, a few large entities may experience pressure on their standalone credit profiles if both funding and asset quality show further signs of deterioration.

The gross NPL ratio for Indian banks rose to 3.7 per cent for the third quarter ending December 2012, with restructured loans accounting for an additional 6 per cent during the same period. The Q4 reporting season is under way.