It was only a few days ago when global rating agency, Moody’s downgraded the standalone credit rating of the country’s largest lender, State Bank of India (SBI), citing weak asset quality position. Following this, the agency has cut the long-term deposit rating of four government banks.
On September 4, Moody’s said the long-term local and foreign currency deposit ratings of Bank of Baroda, Bank of India, Canara Bank and United Bank of India were downgraded to Ba1 from Baa3, and their baseline credit assessments (BCAs) to b1 from ba3. The outlook on the ratings of the four banks is negative.
What is the key takeaway here?
Just like the rater cautioned during SBI’s standalone downgrade, the key concern here too is asset quality in the backdrop of the Coronavirus pandemic. More bad loans are likely to emerge and that will require more capital support for banks from the government. If that support doesn’t come on time, the health of public sector banks (PSBs) will weaken further impacting their ratings. That’s the summary of Moody’s rating action.
“The economic shock from the coronavirus pandemic is exacerbating an already material slowdown in India's economic growth, weakening borrowers' credit profiles and hurting Indian banks' asset quality,” Moody’s has cautioned.
A prolonged financial stress among households, weak job creation, and a credit crunch among non-banking financial companies will lead to a rise in non-performing assets (NPAs), delaying the ongoing clean-up of banks' balance sheets, the agency has said.
To be sure, what Moody’s cautioning here isn’t something new. Already, the Reserve Bank of India (RBI) has warned that the Indian banking system will witness a sharp increase in NPAs by March, 2021.
The central bank expects Gross NPAs of Indian banks to worsen to 14.7 per cent of total loans by the end of March, 2021, in a worst case scenario. Banks have been cautioned to raise capital and keep adequate buffer.
While most private sector banks have beefed up their capital base, state-run banks aren’t able to attract investors on account of their cracked balance sheets and government ownership.
On September 3, Fitch ratings said private banks, which have stronger loss-absorption buffers than PSBs, are likely to gain market share from their state-owned peers in the medium term.
“Private banks' loss absorption buffers, in particular their enhanced capital bases, strengthen their ability to recognise losses upfront with less disruption in their efforts to accelerate market share gains," the global rating agency said.
If one looks closely, Moody’s rating action too reflects similar worries.
“The BCA downgrades take into consideration rising risks to the banks' asset quality as a result of the severe economic contraction, which will result in an increase in credit costs. This increase in credit costs will hurt profitability and also strain the banks' modest capitalization, reversing recent improvements,” Moody’s said.
PSBs will require significant amount of capital from the government going ahead. Question is whether the government, which is walking a tight rope on fiscal situation, is in a position to infuse money.
Analysts have cautioned that investors need to tread carefully while approaching PSBs as they carry a higher risk on account of weak capitalization and high asset quality risk. In a slowing economy, the pressure on asset quality will remain high.
PSBs have not seen the impact of the COVID-19 pandemic on their books on account of the RBI’s temporary measures such as loan moratorium. However, banks are likely to see potential rise in NPAs as the loan moratorium ended on August 31.
Upside risks weigh
While taking the rating action, Moody’s said a downgrade of the banks' BCAs will lead to a downgrade of their ratings. Moody's will downgrade the banks' BCAs if the rating agency expects their solvency to deteriorate further because of an increase in problem loans, coupled with significant declines in earnings, which would weaken their capitalization.
Any indication of diminishing government support for the banks will also lead to a downgrade of their ratings.
On the other hand, the rating outlooks could be changed to stable if macroeconomic conditions in India improve or if there are improvements in the banks' standalone credit strength, including strengthening capitalization or a less severe deterioration in asset quality than currently expected, the agency said.
Going by the industry cues so far, state-run banks will have to go for restructuring of a sizeable chunk of loans to avoid a sudden increase in bad loans. However, this exercise will require them to make substantial provisions that will, in turn, affect their profitability.
In short, Moody’s has given a clear message to the government that capital support for PSBs will remain key going ahead. The ball is now in the government’s court.