Pandemic may set back Indian banking sector's recovery for years

Nonperforming loans are expected to hit 13-14% of total loans for FY2020-21.

The COVID-19 pandemic may set back the recovery of India's banking sector by years, which could hit credit flows and, ultimately, the economy, reports S&P Global Ratings.

The ratings agency expects nonperforming loans in India to hit a new high of 13-14% of total loans by 31 March 2021, leading to raised credit costs.

"In our base case, we expect the nonperforming loans to shoot up to 13%-14% of total loans in the fiscal year ending March 31, 2021, compared with an estimated 8.5% in the previous fiscal year," said S&P Global Ratings credit analyst Deepali Seth-Chhabria.

"Moreover, the resolution of these bad-debt situations will likely unfold slowly, which means banks may also be saddled with a huge stock of bad loans next year. We assume only about a 100 basis point improvement in nonperforming loans in fiscal 2022,” Seth-Chhabria added.

In particular, the negative effects of the crisis will likely be more pronounced in finance companies than in banks.

"Some finance companies lend to weaker customers and have high reliance on wholesale funding. These companies were already facing a trust deficit since the 2018 default of Infrastructure Leasing & Financial Services,” noted S&P Global Ratings credit analyst Geeta Chugh.

“Finance companies also face accentuated liquidity risks due to high proportion of borrowers opting for loan moratorium.”

After years of deterioration, asset quality in the Indian banking system had improved over the past 18 months, helped by higher write-offs, slower accretion of bad loans, and resolution of some big cases under the new bankruptcy law, according to S&P.

Nevertheless, Indian banks were still working through a formidable overhang of nonperforming assets when the COVID crisis struck. This has largely derailed the rehabilitation process.