Asset quality pressures from the previous credit cycle are subsiding, creating a favorable business environment
FinTech BizNews Service
Mumbai, May 13, 2024: Risk appetite through higher loan growth will remain a key consideration for Indian banks' intrinsic creditworthiness despite improved financial performance, says Fitch Ratings. Sustainable risk-adjusted returns are also important, as past volatility weighed heavily on banks' performance in a weaker operating environment. It impeded state banks' ability to defend market share, although private banks' performance also suffered.
Asset quality pressures from the previous credit cycle are subsiding, creating a favorable business environment. This has bolstered banks' potential and appetite for growth. Bank loans grew by 16% in the financial year ended March 2024 (FY24; adjusted for a large bank merger), similar to FY23, and exceeding the 8% CAGR over FY15-FY22. Large private banks gained significant market share in the last credit cycle and continue to grow rapidly; state banks also returned to brisk growth but lagged large private banks.
Retail loans constitute around 10% of system loans, and grew at a 20% CAGR since FY21, fuelled by a shift towards unsecured credit to expand margins. Retail asset quality has held up with an impaired loan ratio of 1.3% in 1HFY24, but accumulation of untested risks due to rapid growth may challenge banks' underwriting standards and risk controls. Fitch's assessment of Indian banks' risk profiles also factors in lower transparency in terms of data disclosures on retail underwriting, such as loan-to-value ratio, borrower debt serviceability, credit bureau scores, and recovery rates, than most Asian banking systems.
India's household debt is among the lowest in the world, despite rising to around 40% of GDP from 38% in FY23. Nonetheless, the Reserve Bank of India (RBI) has expressed concerns through various media regarding the fall in the household savings rate, early delinquencies, higher loans per borrower (43% of consumption loan borrowers had three live loans), and surge in consumption loans, even though secured loans dominate banks' loan books.
Banks' interest in SME and farm loans is also rising, notwithstanding above-average impaired loan ratios of 5% and 7%, respectively, in 1HFY24, though off their peaks in the last credit cycle. State banks have limited flexibility to avoid these sectors due to their quasi-policy roles, but appetite is also driven by high yields. Banks often rely on government guarantees to mitigate risk in SME loans, but there is room for better visibility on risks covered by these guarantees.
Corporate loan transparency is generally better, with disclosures on local rating mix and early delinquencies indicating lower risk-taking in recent years. Loss absorption buffers, particularly at state banks, remain moderate against high concentration risks and renewed interest towards sectors such as infrastructure and construction.
The RBI's recent measures have reinforced safeguards, including improvements in governance, risk management, and reporting. It increased risk-weights on certain loan categories in November 2023 to improve buffers against the potential for build-up of risks, applied punitive business restrictions in specific segments for regulated entities in case of supervisory concerns, and is proposing to increase provisioning on project finance. We believe these measures can foster greater caution towards risk-taking, but their effectiveness is not yet proven through the cycle.
The sector's impaired loan ratio dropped by 110bp to 2.8% in FY24, and credit costs reached a cyclical low of 0.6% of loans, yet fresh impaired loan run rates remain above 1%. Fitch recently affirmed the Viability Ratings of six state-owned banks and two private banks. Five of the state banks' VRs are constrained by their risk profiles, considering fresh untested risks and their more volatile asset quality and earnings records, although risk profile is also an important consideration for private banks given their high appetite for growth.
