Noting that regulatory forbearance has suppressed state-owned banks’ immediate capital requirements by deferring recognition of stressed loans, the report said private banks are most competitive on this front, too.
The report expects earnings and profitability of banks to recover next fiscal on the back of falling loan impairment charges that improved to 1.2 per cent in H1 of FY22, from 1.7 per cent a year ago, because forbearance will limit fresh loan impairments.
Asset quality pressure will ease on the back of improving recoveries from impaired loans, while earnings are supported by adequate pre-provision profit of 3.6 per cent in H1, up 10 basis points against a year ago, thanks to stable net interest margins and operating costs.
But, waning forbearance is likely to pressure profitability, and average operating profit/risk-weighted assets will remain commensurate with banks’ current earnings and profitability scores, the report said.
On the other hand, earnings of private banks should continue to outperform state-owned banks, supported by higher pre-provisioning income buffers and more profitable loan mix along with greater diversification of income base.
However, any rise in loan impairment charges after forbearance unwinds should be somewhat offset by robust loan growth and rising fee income amid steady cost/income ratios, it warned.
The banking market is focused on traditional banking, as reflected in the high share of loans at 55 per cent of assets, it said.
However, it added that over-reliance on interest income can lead to earning volatility should the bad loans ratio rise.
The report also points out that the greater income diversification at private banks partly mitigates this risk.
Retail loans at 25 per cent of sector loans are driving credit growth amid low-risk appetite for corporate and SME loans, although the agency expects corporate credit growth to resume as the economy recovers.
Banks’ risk profiles and financial performance are closely linked to loan underwriting quality, given their conventional business models and high reliance on interest income.
Surplus liquidity and an accommodative interest rate regime since 2020 have also helped the financial system navigate challenges, but banks’ business and revenue generation can face renewed pressure if stress becomes a binding constraint on their modest loss-absorption buffers, particularly at state banks. Yet, it expects moderate growth amid easing risk aversion in 2022.
Private banks and SBI are better positioned as reflected in their lower impaired loans ratios and credit costs, followed by Bank of Baroda and Canara Bank.
The agency expects large private banks to gain market share, as their much better capitalisation can sustain higher loan growth, backed by solid retail franchises, a diversified business mix and stable funding.
Noting that the receding risks are intrinsic to credit profiles, the report expects steady viability ratings supported by a stable operating environment that is being driven by economic recovery, a lower risk of further pandemic-related disruptions and accommodative regulatory stance.
The viability ratings of SBI, ICICI and Axis Bank reflect moderate financial strength, with a BB operating environment score constraining private banks.
SBI is the most competitive of the state-owned banks due to its dominant franchise, vast reach and relative pricing power, which should go onto partly offset some of its capital constraints.
The report expects the economy to outperform peers and forecast real GDP growth of 8.4 per cent for FY22 and 10.3 per cent for FY23. Banks will also benefit from forbearance measures in the interim, such as state guaranteed emergency funding and the option to restructure loans.
This should limit risks to asset quality and earnings and give banks time to build capital buffers before risks to asset-quality re-emerge once forbearance starts to unwind from 2023, said the report.