Moody’s cautions India on problem loans

Deteriorating credit conditions in India’s banking system over the coming months have raised concerns about a hefty increase in problem loans and weakening bank profitability, ratings agency Moody’s warned on Monday.

India’s largely state-owned banking system has emerged mostly unscathed from the global financial crisis and has won wide applause from regulators and policymakers for its conservative approach. The broader economy has also proved resilient, buoyed by domestic demand. India is one of the fastest-growing large economies in the world and is forecast to grow 6.5 per cent this year
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In spite of clear signs of recovery, Moody’s has maintained a negative outlook for the Indian banking system. In a report, the ratings agency flagged up worries about deteriorating asset quality and the volume of restructured loans. During the fiscal year ending March 2009, the level of gross non-performing loans for commercial banks rose by 22.5 per cent, almost double the 11.9 per cent of the previous year.

“The rapid expansion of retail lending in recent years, combined with the slowdown of the Indian economy, has led to increased delinquency rates, especially for unsecured retail loans,” said Nondas Nicolaides, a Moody’s analyst and author of the report.

The agency’s warning comes as expectations rise that the Reserve Bank of India will raise interest rates early next year. At its last policy-setting meeting the bank left rates unchanged but began to tighten up loose monetary policy introduced earlier to defend the economy from the global financial crisis.

The RBI’s requirement that banks increase their cover ratio for non-performing loan provision to at least 70 per cent by next September would “severely affect” bank profitability in the short term, Moody’s predicted. The measure threatens to bring to an end a comfortable run in which the profitability of commercial banks, like the State Bank of India and the Bank of Baroda , has benefited from the high lending environment and net interest income rising sharply in 2009.

Almost 72 per cent of India’s banking system assets are in government hands. The private sector holds close to 20 per cent, leaving foreign banks with about 8 per cent.

Earlier this month, Manmohan Singh, India’s premier, called for deep financial reforms to support credit growth and finance badly needed infrastructure development across the Indian economy. The reform agenda includes developing long-term debt markets, a corporate bond market, strong insurance and pension sectors and futures markets. Government disinvestment in state-owned companies would be accelerated.

Moody's also raised concerns around the capitalisation of some public sector banks and their ability to raise fresh capital to fund future growth while maintaining majority government shareholdings.

The Indian authorities estimate that some public sector banks need injections of about $4.8bn in the coming year to maintain capital adequacy ratios of at least 12 per cent while also expanding credit.