India's weak banking system to strengthen over 2 years: S&P

India's weak banking system will strengthen over couple of years as stressed loans are cleared and capital base expanded by government's fund infusion in state-owned lenders, S&P Global Ratings said today.

In its report titled 'The Worst Is Almost Over For India's Banks', S&P said the ratings on the banks are "more likely to be raised than lowered" in the next 2 years. But, weak risk management and internal-control practices limit the potential for considerable upside, it said.

"We estimate that Indian banks' recognised non-performing loans (NPLs) now cover a substantial part of weak loans in the system, which comprise about 13-15 per cent of total loans," S&P Global Ratings Credit analyst Geeta Chugh said.

S&P said a turnaround in the earning performance of India's banks should take place in fiscal 2020 (ending March 31, 2020). This turnaround could be delayed if large unexpected NPLs materialise in the agriculture sector, where for example government-granted loan repayment waivers could hurt credit discipline. The loan-against-property segment may also be vulnerable, it said.

"India's weakened banking system is set to strengthen over the next couple of years as stressed loans are cleared and capital injections from the government shore up eroded capital bases," S&P said .

Banks categorised an increasing proportion of weak loans as NPLs due to more stringent requirements by the Reserve Bank and government.

S&P said this more realistic recognition, coupled with rebounding corporate profits, and quicker resolution of nonperforming assets under the new bankruptcy law, will help banks gradually recover from a protracted bad-debt cycle.

"We believe the RBI's strengthening norms and more stringent timelines mean that banks will increasingly find it more difficult to window-dress accounts to hide the true level of weak assets," Chugh said.

S&P said the central bank is reportedly conducting another asset quality review, focusing on 240 corporate loans. Many of these loans are already classified as NPLs, but the RBI is said to be investigating whether they are under-provisioned.

"Another year of high provisioning is likely as public sector banks clean up their balance sheets and provide for losses on their stressed assets. Other drags on earnings include lower treasury income amid rising interest rates," it said.

The government is working on a four-pronged strategy to improve the health of the banking sector: recognition, recapitalisation, resolution, and reform. The first three of the "4Rs" has progressed significantly, but in our view, India hasn't done enough with respect to reform, S&P said.

S&P's stable outlook on banks is underpinned by the expectations of a very high likelihood of government support.

"The government's ongoing recapitalisation programme of Rs 2.1 lakh crore (USD 32 billion) will help shore up depleted capital positions. While we no longer think this programme is sufficient to meet the sector's capital needs, we believe the government could arrange additional support as needed," Chugh said.