India Ratings and Research (Ind-Ra) revised the outlook on the overall banking sector to "improving" for FY23 from "stable", calling the banking system's health at its best in decades.

The improving health trend that began in FY20 is likely to continue into FY23, the research and rating agency said. "Key financial metrics are likely to continue to show improvement in FY23, backed by strengthened balance sheets and an improving credit demand outlook with an expected commencement of corporate capex cycle."

While the tightening liquidity would push up interest rates, impacting treasury gains, it would at least partially offset in the short term as loans get repriced faster than deposits, India Ratings said, adding that almost one-third of the system's loans are linked to external benchmark rates.

Ind-Ra has marginally revised its credit growth estimates to 8.4% from 8.9% for FY22 and 10% for FY23.

The growth, according to the ratings firm, will be supported by a pick-up in economic activity following the first quarter of the current financial year, higher government spending on infrastructure and a revival in retail demand.

The agency estimates gross non- performing assets (GNPA) at 6.3% and stressed assets at 8.7% for FY22 and at 6.1% and 7.6%, respectively, for FY23. It further expects provisioning cost for FY22 at about 1.5% and 1% in FY23.

Asset quality in the retail and micro, small and medium (MSME) segments are most impacted due to the pandemic, Ind-Ra estimates show. The stressed asset ratio (GNPA + restructured) in the retail asset segment is expected to almost double to 5.7% at end-FY22 from 2.9% at end-FY21, whereas for the MSME segment, it could increase to 15.8% from 11.7%.

The rating agency has a 'stable' outlook on large private banks for FY23, highlighting their continued market share gains in both assets and liabilities.

On public sector banks (PSBs), the rating agency said that FY23 reflects reasonable capital buffers, low overhang of corporate stress in terms of expected slippages and manageable impact of Covid-19. "Ind-Ra expects PSBs to look for growth across sectors and benefit from loan recoveries, considering their highest profitability in the past six years. In FY22, Ind-Ra has revised the negative outlook to stable on long-term issuer ratings on five government-owned banks."

This comes days after Reserve Bank of India (RBI) governor Shaktikanta Das cautioned that banks and non-banking financial companies need to be watchful as the unwinding of the loose monetary policies could have spillover effects. "We have to be, however, watchful of the impact of the pandemic on the banking and NBFC sectors when the effects of regulatory reliefs and resolutions fully work their way through. Banks and other financial entities would be well advised to further strengthen their corporate governance and risk management strategies to build resilience in an increasingly dynamic and uncertain economic environment. They also need to continue the process of capital augmentation and building up of appropriate buffers," Das had said.

The monetary policy committee had kept both the repo and the reverse repo rates unchanged, citing an incomplete recovery from the pandemic. It was the tenth straight meeting where the key policy rates were left unchanged.

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