If you think that banking is going through a crisis of confidence, ratings major S&P Global Ratings has some news for you. In its report titled The Worst Is Almost Over For India's Banks, S&P Global Ratings noted that India’s weakened banking system is set to strengthen over the next couple of years as stressed loans are cleared and capital injections from the government shore up eroded capital bases.

“We estimate that Indian banks’ recognised non-performing loans (NPLs) now cover a substantial part of weak loans in the system which comprises about 13%-15% of total loans,” said S&P Global Ratings credit analyst Geeta Chugh.

After the Reserve Bank of India (RBI) put out stringent recognition norms, Indian banks have categorised a big proportion of weak loans as NPLs. This, coupled with rebounding corporate profits, and quicker resolution of nonperforming assets under the new bankruptcy law, will help banks gradually recover from a protracted bad-debt cycle, according to S&P.

“We believe the Reserve Bank of India’s strengthening norms and more stringent timelines mean that banks will increasingly find it more difficult to window dress accounts to hide the true level of weak assets,” Chugh added.

Some bouts of turbulence cannot be ruled out, as RBI is reportedly conducting another asset quality review focussing on 240 corporate loans. An S&P Global Ratings’ release notes that many of these loans are already classified as NPLs, but RBI is said to be investigating whether they are under-provisioned.

So, another year of high provisioning is likely as public sector banks clean up their balance sheets and provide for losses on their stressed assets. Other drags on earnings include lower treasury income amid rising interest rates. “A turnaround in the earning performance of India’s banks should take place in fiscal 2020 (ending March 31, 2020),” the release notes. This turnaround could be delayed if large unexpected NPLs materialise in the agriculture sector, where for example government-granted loan repayment waivers could hurt credit discipline. “The loan-against-property segment may also be vulnerable,” the note adds.

The government is working on a four-pronged strategy to improve the health of the banking sector: recognition, recapitalisation, resolution, and reform. The first three of the “4Rs” has progressed significantly, but in S&P Global Ratings’ view, India hasn’t done enough with respect to reform. And, the rating major’s stable outlook on banks is underpinned by its expectations of a very high likelihood of government support.

“The government’s ongoing recapitalisation programme of Rs 2.1 trillion ($32 billion) will help shore up depleted capital positions,” Chugh added. “While we no longer think this programme is sufficient to meet the sector’s capital needs, we believe the government could arrange additional support as needed.”

Further, the ratings major believes the risk to its view is on the upside: ratings are more likely to be raised than lowered in the next two years. That said, weak risk management and internal-control practices limit the potential for considerable upside.

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