MUMBAI: Despite forecasting for a marginal deterioration in the asset quality that has improved massively in the past few years, international rating agency Moody’s has said it has a stable outlook for the country’s banking system, citing strong fundamentals of the lenders along with robust economic growth. The agency also expects GDP growth to exceed 6.5% next fiscal.
The agency said the asset quality stress is coming from the rising stress levels in unsecured retail loans, microfinance loans and small business loans. The agency also expects system-wide loan growth to slow to 11-13% in fiscal 2026 from an average of 17% for March 2022-March 2024 as banks seek to keep loan growth in tandem with deposit expansion.
The statement comes two days after RBI forced the fourth largest private sector lender Indusind Bank admitting to have unreported its losses from the forex derivatives play for the past few years. The bank said the restating of its derivatives book will lead to a networth erosion of 2.35% which will lead to around Rs 2,100 crore of decline in its profitability. The admission had the bank shares tanking by over 27% on Tuesday eating up as much as Rs 19,000 crore of its market value which is even less than the still struggling Yes Bank.
The worry is that RBI is reportedly asking all banks which have a large derivatives plays to closely reassess their operations.
“Our outlook for Indian banking system is stable. We expect the operating environment for banks to remain favorable, helped by government capex, tax cuts for middle-class that will boost consumption and monetary easing. We also expect the real GDP growth to exceed 6.5% next fiscal,” Alka Anbarasu, an associate managing director of the agency, said in a note Wednesday.
She further said banks' profitability will remain adequate as declines in net interest margins (NIMs) are likely to be marginal amid modest rate cuts. Banks also have strong core capital, supported by internal accruals that keeps pace with asset growth and easy access to a deep domestic equity market.
On asset quality Anbarasu says nonperforming loans ratio will increase only moderately after substantial improvements in recent years, although divergence will emerge among lenders based on underwriting standards and target borrower groups. The systemwide NPL ratio dropped to 2.6% as of the end of September 2024 from 7.3% at the end of March 2021 because of recoveries and write-offs of legacy problem loans while the slippage ratio is low.
“We expect the systemwide NPL ratio to be 2-3% in the next 12-18 months, while slippage ratios and loan-loss provisioning costs to increase somewhat from cyclically very low levels. This is because of the moderation of economic growth in recent quarters, the impact of past rises in interest rates and the aging of unsecured retail loans, including microfinance loans, and some small business loans. This is because unsecured retail loans are only 10% of total systemwide loans, and banks have built sufficient loan-loss reserves against NPLs. The quality of corporate loans will remain healthy, supported by deleveraging and earnings growth,” she said.
On the capital adequacy of banks, she said it will continue to remain strong as their internal capital generation keeps pace with capital consumption, with their dividend policies continuing to be prudent.
As of March 2024, the systemwide tier 1 capital ratio was broadly steady at 14.8, down from 15 a year earlier, despite an increase in risk weights for exposures to non-banks and unsecured retail loans.
Banks' funding and liquidity will also be stable, with loans growing in line with deposits. We continue to expect strong government support for banks in times of need, she added.
On the economy, she said economic growth will pick up from the ongoing cyclical slowdown that began mid-2024. We expect GDP growth to reaccelerate from now and is likely to exceed 6.5% next fiscal on the back of continuing government capex and tax cuts for the middle class which will boost consumption and the monetary easing on the other. The agency still expects the economy to print in only at 6.3% in fiscal 2025.
The GDP slowed to 5.6% in the September 2024 quarter but rebounded to 6.2% in the December quarter.
Anbarasu expects retail inflation to average at 4.5% in fiscal 2026 down from 4.8% in FY25.
The RBI, which has been holding tight for almost five years—from May 2020, lowered its policy rate by 25 bps to 6.25% in February 2025. But Moody’s now expects the further rate cuts to modest, as she feels that the central bank is having a cautious stance due to the amid global uncertainty following US trade wars, and the rupee weakness.