According to a report, strengthening economic recovery and stable financial metrics will help state-owned banks generate stable earnings in the next fiscal year, helped by the gradual lifting of regulatory forbearance later in the year.
Fitch Ratings also said in Friday’s report that private sector banks are better positioned to reap the benefits of the recovery and will continue to increase their market share in both loans and deposits.
Noting that regulatory leniency has stifled immediate capital requirements for state-owned banks by postponing recognition of distressed loans, the report said private banks are also the most competitive on this front.
The report expects banks’ earnings and profitability to recover next fiscal year on falling loan loss provisions, which improved to 1.2% in the first half of FY22 from 1.7% a year ago, as leniency will limit new loan writedowns.
Asset quality pressures will ease on better impaired loan recoveries, while stable net interest margins and operating expenses support earnings with a reasonable profit before provisioning of 3.6% in the first half, up 10 basis points year-on-year.
However, easing leniency is likely to put pressure on profitability and average operating profit/risk-weighted assets will be in line with banks’ current earnings and profitability figures, the report said.
On the other hand, private bank earnings should continue to outperform state-owned banks, supported by higher pre-deployment revenue buffers and a more profitable loan mix, as well as greater income base diversification.
However, any increase in loan allowances following the lifting of the forbear should be somewhat offset by robust loan growth and rising fee income on constant cost-income ratios, she warned.
The banking market is focused on traditional banking, which is reflected in the high loan share of 55% of assets, it said.
However, it added that over-reliance on interest income could lead to earnings volatility should the non-performing loan ratio rise.
The report also notes that private banks’ greater income diversification mitigates some of this risk.
Retail lending, which accounts for 25% of sector lending, is driving loan growth amid low risk appetite for corporate and SME lending, although the agency expects corporate lending growth to resume as the economy recovers.
Given their conventional business models and high reliance on interest income, banks’ risk profile and financial performance are closely linked to the quality of their lending.
Excess liquidity and an accommodative interest rate regime since 2020 have also helped the financial system weather challenges, but banks’ business and revenue generation may come under renewed pressure if stress becomes a mandatory constraint on their modest loss-absorbing buffers, particularly for state banks. Nevertheless, it expects moderate growth with decreasing risk aversion in 2022.
Private banks and SBI are better positioned, reflected in their lower non-performing loan ratios and borrowing costs, followed by Bank of Baroda and Canara Bank.
The agency expects large private banks to gain market share as their much better capitalization can sustain higher lending growth, backed by solid retail operations, a diversified business mix and stable funding.
With the risks inherent in credit profiles receding, the report expects stable profitability ratings, backed by a stable operating environment supported by the economic recovery, reduced risk of further pandemic-related disruptions and an accommodating regulatory stance.
SBI, ICICI and Axis Bank profitability ratings reflect moderate financial strength, with a BB Operating Environment score limiting private banks.
SBI is the most competitive of the state-owned banks due to its dominant franchise, wide reach, and relative pricing power, which should partially offset some of its capital constraints.
The report expects the economy to outperform its peers, forecasting real GDP growth of 8.4% for FY22 and 10.3% for FY23. Banks, meanwhile, are also benefiting from forbearance measures such as government-guaranteed emergency funding and the option to restructure loans.
This should limit risks to asset quality and returns, and give banks time to build capital buffers before asset quality risks reappear once forbearance begins to ease from 2023, the report said.
