Moody's upgrades Indian banks' medium term outlook to 'stable'

Ratings agency Moody's has upgraded its medium term outlook for India's banking system to 'stable' from 'negative' on the basis of what it sees as an improvement in the operating environment for banks.

But the agency says the pace of improvement is likely to be slow and steady as the recovery in asset quality is expected to be U-shaped rather than V-shaped, due to highly leveraged balance sheets.

"The stable outlook over the next 12-18 months reflects expectation that the banks' gradually improving operating environment will result in a slower pace of additions to problem loans. It will lead to more stable impaired loan ratios," said Srikanth Vadlamani, vice president and senior credit officer, Moody's.

Moody's has based its outlook assessment of five drivers: Operating Environment (improving); Asset Risk and Capital (stable); Funding and Liquidity (stable); Profitability and Efficiency (stable); and government support (stable).

Operating Environment: Moody's expects India to record a GDP growth of around 7.5 per cent in 2015 and 2016. Growth has been supported by low inflation and the gradual implementation of structural reforms. Moody's points out that an accommodative monetary policy should support the growth environment.

Asset Risk and Capital: Moody's expects asset quality to stabilize. While, it expects the banks' stock of non-performing loans (NPLs) to continue to rise, Moody's says the pace of new impaired loan formation in the current financial year will be lower than the levels seen in the past four years. 

Capital Levels: Moody's says the public-sector (PSU) banks, with low capital levels, exhibit common equity Tier 1 ratios of only 6-10 per cent, and their coverage of non-performing loans with loan-loss reserves averages 55 per cent. 

While the government's plan to inject Rs70,000 crore is credit positive, the ratings agency points out that it is still short of the banks' overall capital requirements. "Ability to access equity capital markets remains key if the PSU banks have to address their capital shortfall," states the report adding that by contrast, high capital levels are a credit strength of the private-sector banks that Moody's rates.

Funding & Liquidity: Moody's says funding and liquidity are credit strengths for Indian banks because retail deposits are their primary source of funding.  "Most banks comply comfortably with required liquidity coverage ratios, even though only part of their holdings of government securities is categorized as high-quality liquid assets." it adds.

Moody's rated 15 banks in India that together account for around 70 per cent of system assets. Four are private-sector banks and the remaining 11 are PSU banks.