Moody's retains negative outlook for banks on local woes

Moneycontrol Bureau

Rating agency Moody's Investors Service has maintained its outlook on the Indian banking system to negative for the next 12-18 months, citing the continued challenging nature of its domestic operating environment. It rating has been negative since November 2011.

"This environment is characterized by slow economic growth, high inflation, high interest rates, and a weak local currency, and we expect these factors to lead to a further deterioration in asset quality, an increase in provisioning costs, and a fall in profitability," Vineet Gupta, vice president and senior analyst at Moody's said.

Moody's said the government provides strong support to public sector banks in the form of annual equity infusions, and all banks are mandated to meet loan quotas for certain sectors of the economy. This implies a high degree of involvement by the government in the banking sector and related public accountability.

The ratings agency also said loan classification, especially regarding restructured loans, as well as provisioning requirement practices in India is weak. "Loan classification and provisioning requirements mask the extent of the banks' asset quality and capital challenges," Gupta said.

The government has budgeted Rs 15,000 crore capital infusion in public sector banks for the current financial year. Unlike last year, when the Centre and the Life Insurance Corporation infused equity and increase stake, this time the government wants banks’ want to go for a rights issue. However, some banks are still hoping at direct equity infusion as they are unsure of investor appetite. Also, the money raised via rights issue may fall well short of target as the current market capitalisation of the banks is very small compared to their capital requirements.

According to the Reserve Bank, Indian banks need about Rs 5 lakh crore of additional capital to meet the Basel-III norms. Basel-III, which comes into effect from January 1, 2013, requires banks to maintain a minimum overall capital adequacy of 11.5 percent (against the current 9 percent) by March 31, 2018.

According to Moody's, the government would provide extraordinary support in the form of unsecured loans and/or capital injections to both the public and the rated private banks.

On the positive side, Moody's said the strong business franchises of Indian banks support low-cost funding and help maintain sizable lending margins.

The news comes in the backdrop of the finance ministry officials' meet today with Moody's analysts, wherein they will make a pitch for an earnings upgrade. (read here) Earlier this year, Standard & Poor's (S&P) and Fitch had downgraded their outlook for India. In fact, yesterday Fitch said that policy slippage and a hike in fiscal deficit could lead to a downgrade and investment bank Morgan Stanly asked investors to stay away from several public sector banks citing asset quality problem.