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Capital woes continue for Indian Banks: Fitch

Fitch Ratings’ outlook on the Indian banks sector is likely to remain negative until the banks address their weak core capital positions against mounting bad debt and poor financial performance, says Fitch Ratings.

The capital position of state banks is most at risk, with the core capital ratios of 11 of India’s 21 state banks below the 8% common equity Tier 1 (CET1) regulatory minimum that comes into place at financial year-end March 2019 (FYE19). Banks’ credit costs rose sharply following regulatory changes aimed at accelerating bad-loan recognition and led to losses that cumulatively eroded nearly all of the $13bn in government capital injected in FY18, adding to capital positions which were already weak. Loan growth improved to 10.4% in FY18, from 4.4% in FY17. This improvement was shouldered by a few large banks, and sustaining the growth momentum will be difficult without adequate capital replenishment.

The financials of large private-sector banks weakened further in FY18, but are better than those of their state-owned counterparts, 11 of which are under the central bank’s prompt corrective framework. State banks’ average non-performing loan (NPL) ratio of 15.6% was more than double that of private banks, which also had a Fitch-estimated average core capital ratio of 13.3%; nearly 500bp higher than that of state banks.

We believe Indian banks will need $40 bn-55 bn in additional capital to meet Basel III requirements by 2019, with state banks requiring the bulk of this amount; most of the capital is likely to be used for meeting minimum capital requirements and absorbing NPL provisions, around three quarters of which are in the form of CET1. The state is likely to be forced into providing most of the required capital, since capital raisings remain challenging due to state banks’ weak equity valuations.

Indian banks’ Q1FY19 performance improved slightly on declining credit costs and steady loan growth. However, the $151bn stock of bad loans remains a risk for the sector’s weak income base, which is vulnerable to ageing provisions and slower NPL resolution. We believe the sector’s legacy problems have been largely recognised, but the system NPL ratio could witness more upside due to residual stress and new risks emerging out of the retail and SME sectors.

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