Indian banks' performance till Dec 22 exceeds expectations: Fitch Ratings

The pace at which the asset quality and profitability of Indian banks have improved has exceeded expectations, while capital buffers are broadly in line with Fitch Ratings' projections. There is a further upside in performance and this could persist for longer than expected, according to the agency.

The sector's impaired-loan ratio declined to 4.5 per cent in the first 9 months of FY23 (9MFY23), from 6.0 per cent at FY22. This was nearly 60 basis points below Fitch's FY23 estimate.

Increased write-offs have been a key factor, but higher loan growth, supported by lower slippages and improved recoveries, have also played a role. Fitch expects a further improvement by FYE23, although banks still face the risk of asset-quality pressure associated with the unwinding of loan forbearance in FY24.

Sound economic momentum has contributed to a further drop in credit costs to 0.95 per cent in 9MFY23, according to Fitch's estimate, compared with 1.26 per cent in FY22. Banks have a reasonable tolerance to absorb pressure from credit costs and margin normalisation, without affecting FY24 profitability forecasts.

Pre-impairment operating profit at private banks, at 4.5 per cent of loans, offers greater headroom than the 3 per cent at state banks and supported private banks’ return on assets of 1.9 per cent, which far exceeded state banks’ 0.7 per cent.

A sustained improvement in the financial performance of Indian banks bodes well for the sector’s intrinsic risk profiles. With Covid-19 pandemic-related risks largely in the background, there has been a steady improvement in banks' balance sheets over the past three years, in part due to forbearance.

The agency said that sustained easing of financial-sector risks could support a higher operating environment score. However, this will depend on the assessment of various factors, such as medium-term growth potential, borrower health, and loans under regulatory relief, rather than just near-term bank performance.

There is also a risk that continued strong loan growth may lead to selective or incremental increases in risk appetite. The net interest margin compression and higher credit costs post wind-down of regulatory forbearance could still weigh on financial profiles, the rating agency said.

Sustained high loan growth, accompanied by rising risk density, could pressure capital. The sector's common equity Tier 1 (CET1) ratio rose by around 54 bp in 9MFY23 to 13.3 per cent, alongside a 460bp drop in the net impaired loans/equity ratio to 9.6 per cent.