India’s economy is expected to see a recovery in 2021 which will reduce the likelihood of a sharp deterioration in asset quality at the country’s public sector banks. However, banks’ capitalization will remain insufficient to absorb unexpected shocks and support credit growth, according to Moody’s Investors Service.

“Various measures by the Indian government to support borrowers have helped curb growth in public sector banks’ nonperforming loans (NPLs), and the volume of restructured loans is not as large as we anticipated,” says Rebaca Tan, a Moody’s Assistant Vice President and Analyst.

Asset quality at the five largest public sector banks (PSBs) in India – State Bank of India, Bank of Baroda, Punjab National Bank, Canara Bank, and Union Bank of India – improved mildly in the first nine months of fiscal 2021 despite an economic contraction exacerbated by the pandemic.

The gross NPL ratios of the five banks declined by an average of about 100 basis points as of the end of 2020 from a year earlier, even including loans that have become delinquent since the end of August 2020 but are not formally classified as NPLs because of a pending case in the Supreme Court.

On the other hand, NPL recoveries slowed across all five banks in the first nine months of fiscal 2021 from the whole of the prior year because of the pandemic, which has not only caused economic disruptions but also led to the suspension of resolution proceedings under the Insolvency and Bankruptcy Code until March 2021, Moody's noted.

However, it expects recoveries will gradually pick up in the next few quarters as the economy recovers.

Meanwhile, Moody's also expects the banks' capital buffers to remain insufficient to both absorb any unexpected stress and support credit growth.

India’s public sector banks will continue to face capital shortages as their profitability remains weak given high credit costs, leaving them vulnerable to any unexpected stress, the rating agency said.

Although India's economy will recover, Moody's expects it will be uneven among industries and vulnerable to setbacks. The banks' asset quality can also deteriorate more than anticipated, with exposures to the MSMEs, in particular, posing risks, Moody's said.

The government plans to infuse Rs 20,000 crore in equity capital into public sector banks in fiscal 2022, on top of the Rs 20,000 crore budgeted in fiscal 2021.

“While the government’s capital infusion into public sector banks will help them meet Basel capital requirements, it will not boost credit growth,” adds Tan.

First Published:Feb 11, 2021 11:12 AM IST