Indian public banks' asset quality deemed much weaker than expected

Improvement has been marginal.

It has been noted that the improvement in the credit profiles of Indian public-sector banks will be achieved only in the medium term, given their high levels of impaired loans and weak capital positions.

According to a release from Moody's Investors Service, public-sector banks represent more than 70% of total banking system assets in India.

"The improvement in the asset quality of Indian public-sector banks for the fiscal year ended 31 March 2015 was marginal and much weaker than we had expected at the start of the same year," says Srikanth Vadlamani, a Moody's Vice President and Senior Credit Officer.

"A longer time-frame is needed for the credit profiles of public-sector banks to improve, because their asset quality is tied to the slow, multi-year recovery of corporate balance sheets, and the lagging recognition of associated credit costs," adds Vadlamani.

Here's more from Moody's Investors Service:

Vadlamani was speaking at the first Moody's and ICRA Annual Credit Conference in Mumbai, held on Wednesday, 13 May.

Vadlamani says that the overall debt servicing metrics of Indian corporates are weak, exhibiting very high debt levels that will require years to improve.

While asset sales and fresh capital raising activities increased in the fiscal year ended 31 March 2015, these developments have not meaningfully lowered debt levels among Indian corporates.

Vadlamani notes that public-sector banks exhibit significant capital requirements over the next few years, but their internal capital generation capacity is weak, while access to equity markets has been difficult. The banks are therefore highly dependent on the Indian government for fresh capital.

However, in February 2015, when the government announced its allocation from the budget for the fiscal year ended 31 March 2015, it made a significant departure from its previous approach to capital infusions into state-owned banks.

Instead of allocating proportionally more capital to weaker banks, the government only allocated capital into relatively profitable banks, and completely excluded weaker banks that did not meet its new efficiency criteria from capital infusions.

Given the low capital levels of public-sector banks as a whole, the government's selective approach to capital infusions will put further negative pressure on the credit profiles of weaker banks.

As for corporate governance, Vadlamani notes that the government has recently taken some steps towards improving corporate governance at public-sector banks; including the separation of duties between chairmen and chief executive officers, and moves to attract talent from the private sector into public-sector banks. Vadlamani says that while these moves are credit positive for the banks, much more will be required to address the structural governance issues at public-sector banks.

On the modifications to India's framework for corporate bankruptcy, Vadlamani says the Indian budget's proposed introduction of a new bankruptcy law is credit positive if implemented as recommended, because the current weak framework is a major impediment in the banks' enforcement of creditor rights.

Vadlamani points out that the poor implementation of such bankruptcy regimes in the past was due to institutional capacity issues, and that unless such issues are addressed, the weak mechanisms for the resolution of stressed corporates will remain a structural weakness within the Indian banking system.