Indian banks face systemic risk as the country sorts through the aftermath of the COVID second wave. Lenders struggled with a high level of weak loans well before the pandemic struck and, clearly, conditions have deteriorated. S&P Global Ratings says it expects the second wave to impair the performance of Indian financial intuitions in the first half of fiscal year 2022, with much resting on the effectiveness of government measures to address this problem.
According to the ratings agency, Indian banking sector's weak loans will likely remain elevated at 11%-12% of gross loans in the next 12 to 18 months, while credit losses should remain high at 2.2% before recovering to 1.8% in fiscal 2023.
"The second wave has front-ended weakness in asset quality," says Deepali Seth Chhabria, credit analyst at S&P Global Ratings. "Financial institutions face a strained first half amid weak collections and poor disbursements."
The Union government has recently announced support for the microfinance and tourism sectors that should help struggling borrowers. This support comes on top of recently extended loan guarantees to small and midsize enterprises (SMEs).
S&P says, "A COVID resurgence involving new and potentially aggressive variants, and a vaccine rollout that undershoots our current expectations, remain the key downside risks. Limited vaccine supplies and people's reluctance to take doses have held back the country's inoculation program."
Fully vaccinating roughly 70% of the country will likely take at least until the first half of 2022, which leaves the economic recovery highly vulnerable to COVID setbacks, particularly if fresh outbreaks trigger new lock-downs, it added.
The Indian economy has been in recovery mode since June. This followed a sharp contraction in the economic activity in April and May after the government imposed localised lock-downs across much of the country. The lock-downs have helped contain the second wave, which has been responsible for about 235,000 deaths.
According to the ratings agency, consumption indicators, such as vehicle sales, fell sharply in May 2021 and consumer confidence remains downbeat in the country. The latest outbreak has less severely affected the country's manufacturing and exports than was seen during the first wave of infections in 2020; but services continue to be disrupted.
"The current recovery should be less steep than the bounce that unfolded in late 2020 and early 2021. Households are running down savings. A desire to rebuild their cash holding may delay spending even as the economy reopens. While we expect real gross domestic product (GDP) growth of 9.5% in fiscal 2022, this is off a low base," S&P says.
Banks have much to digest in the quarter ahead, the ratings agency says, adding disbursements slowed considerably in April and May this year. The credit that banks extended fell by about 1% in the first two months of this fiscal year. The drop was largely seasonal--there were similar declines in the same period for fiscals 2018 and 2019. That said, strains on finance companies can go beyond this seasonal effect, it added.
For example, Bajaj Finance Ltd, in its mid-quarter update, said sales volumes for its consumer durables and auto finance businesses in May were just 40% of what management expected. "We believe credit growth in India started improving in June, and will continue to do so," S&P says.
Due to lock-downs, the collection efficiency for several finance companies fell by up to 5%-15% in April and May. Lenders catering to prime borrowers were generally less affected. Small and medium enterprise (SME) borrowers, which comprise about 17% of total loans, and low-income households have been most affected.
According to the ratings agency, tourism and recreation-related sectors, commercial real estate, and unsecured retail loans may contribute to higher non-performing loans (NPLs). However, it says, the banking system's exposure to many of these segments is moderate, and should have only a limited effect.
"Housing finance, excluding affordable housing and gold loans will likely be less affected compared with financing for micro enterprises or commercial vehicles. The finance companies will likely be more impacted than banks," it added.
S&P sees asset-quality strains likely continue long into fiscal 2022. It says, "While the incremental NPLs will remain elevated in the current fiscal year, resolutions should pick up, which will limit the increase in bad debt. The establishment of a bad bank to manage lenders' troubled assets could also result in a faster resolution of NPLs."
India's NPL management challenges, typically, lay in the execution of policies, and S&P says it expects this to be the case in the year ahead.
The Indian government has laid out ambitious measures. Initiatives include the State's emergency credit guarantee scheme, which bolsters the working capital of SMEs. The government recently added Rs1.5 trillion to this programme. This comes on top of its existing program of Rs3 trillion extended to SMEs and the partial guarantee scheme for the finance companies. The measures collectively should alleviate stresses to the country's banking system.
The government has also announced a Rs75 billion credit guarantee scheme for banks' new lending to microfinance borrowers through microfinance institutions. The government will guarantee up to 75% of such loans.
"Though the plan will add liquidity, some of the affected borrowers may struggle to repay their accumulating debt. This, along with a second restructuring scheme to address disruptions caused by the second COVID wave, should push back banks' NPL recognition. The volume of restructured loans will likely rise," S&P says.
According to the ratings agency, Indian banks are better prepared to bounce back from the second wave than they were during the last downcycle. Institutions have continued to raise capital from the equity markets and the government.
Private sector banks such as ICICI Bank Ltd and Axis Bank Ltd raised equity capital in the last fiscal year, and public sector banks have jumped on this bandwagon. IDBI Bank raised Rs14.4 billion in equity in December 2020. Indian Bank also raised Rs16.5 billion in equity in June 2021, after issuing Additional Tier-1 (AT-1) notes totalling Rs20 billion at a coupon of 8.44%, in December 2020. Many other banks have also announced plans to raise capital, including hybrid capital.
S&P says it expects return on average assets to remain at 0.7% in fiscal 2022, similar to fiscal 2021, but an improvement compared with the 0.1% seen in fiscal 2020. Banks have already created COVID-related provisions of 0.5%-1.5% of loans. Additionally, the central bank has allowed banks to use all other floating and countercyclical provisions to address NPLs.
"The next six months should be defined by the effectiveness of policies to contain long simmering bank-sector strains, with much potential for COVID-related flare-ups," says Geeta Chugh, credit analyst at S&P Global Ratings.