The worst is almost over for worn out Indian banks

An earnings turnaround is in sight by 2020 as banks start shedding off bad loans.

India’s ailing banking sector is poised for a mild recovery in 2020 as the protracted bad loan cycle that have crippled operations in recent months, approaches its timely end, according to credit rating agency S&P. 

Tighter regulations from the Reserve Bank of India (RBI) have prompted lenders to step up their nonperforming loan (NPL) recognition, leading to a record loss of more than $9b for public sector banks (PSUs) in Q1 where stressed assets are the highest.

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Banks have been working overtime to clean up their balance sheets and set aside for losses on their stressed assets. As a result, nearly all banks have booked year-end losses in Q4 with the exception of ICICI, Kotak Mahindra, HDFC and Indian Bank.

However, the more stringent bad loan recognition rules along with the new bankruptcy law which resolves NPLs at a faster pace is expected to lend support for Indian banks’ rebound. The steel sector and cement companies that are swinging into recovery amidst a favourable commodity cycle is also a plus.

“We believe the RBI's strengthening norms and more stringent timelines mean that banks will increasingly find it more difficult to window-dress accounts to hide the true level of weak assets,” S&P said in its report.

Banks and government-owned finance companies like Power Finance Corp and Rural Electrification Corp. Ltd., have also inked inter-creditor agreements empowering the lenders to sign off on resolutions as long as 66% of affected lenders agree.

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Assurance of government support props up the stable growth outlook of India’s embattled state lenders following a $32b (INR2.1t) recapitalisation programme. There are also reports that the government is planning to hold talks with the central bank to relax the minimum common equity (CET) Tier-I ratio from RBI's prescribed 5.5% to 4.5% in line with Basel norms.

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The RBI expects PSUs that are under prompt corrective action could witness sharp declines in their capital-to-risk-weighted assets ratio (CRAR) to 6.5% by March 2019 from 10.8%, in the absence of any capital infusion.

Besides writing off weak loans, banks would also need capital to meet their Basel III requirements, which will increase further in March 2019.

“We are no longer certain that the government's INR2.1 trillion recapitalization program will be sufficient to restore capital bases, however. The government has already pumped in about INR880 million in the quarter ending March 2018 and the rest of funds will be injected this year,” said S&P.

However, banks could sell non-core assets and shrink their balance sheets with PSUs surrendering their market share to private players amidst the capital crunch. 

“The recovery rate in this cycle will remain close to the previous 26%. The real benefit of the new bankruptcy code will be in the next credit cycle. Nevertheless, the resolution of NPLs should help reduce overall NPLs in the system in this year,” S&P added.

Photo from I, P.K.Niyogi, CC BY-SA 3.0