Indian banks: Glass half full or half empty?

Have bad loans across the country’s banking sector peaked? It’s a question that has been asked for at least the past 4-6 quarters. While each time the answer is in the affirmative, the data refuses to support it.

Bad loans have risen consistently even on a quarter-on-quarter basis since the quarter ended March 2014. The cumulative amount of bad loans across the 39 listed banks rose 33% between the March 2014 quarter and the June 2015 quarter. Most state-owned banks are still to report earnings for the September 2015-ended quarter.

Now once again, the hope is building that the worst of the bad loan problem is behind us. A day after rating agency Moody’s Investor Services revised the outlook of the Indian banking sector to “stable” from “negative”, saying stressed assets have peaked, peer agency Fitch Ratings has taken a similar view.

In a report released , Fitch said that the stressed asset ratio across the banking sector has largely peaked and that non-performing asset (NPA) pressures are slowly subsiding.

“Fitch expects the Indian banks’ stressed assets ratio to marginally improve to 10.9% (as a percentage of total loans) in FY16 from 11.1% in FY15, we expect incremental NPLs (non-performing loans) to subside gradually with greater traction around cyclical recovery,” said the rating agency.

While potential challenges remain in sectors like infrastructure, banks are likely to exercise the sector-specific provisions available to restructure and reschedule loans—some of which may “escape as performing (loans),” said Fitch.

Moody’s, in its Monday report, said that its negative outlook on the Indian banking sector has been driven mainly by deteriorating asset quality, which it believes will now start to improve.

“While the stock of non-performing loans may continue to rise, the pace of new impaired loan formation in the current financial year ending 31 March 2016 will be lower than the levels seen in the past four years,” said Moody’s, adding that the recovery in asset quality will be U- rather than V-shaped, because corporate balance sheets remain highly leveraged.

Fitch, too, highlighted the stressed corporate balance sheets and said that the steel, engineering and construction sectors are the most at risk.

But there are still a number of questions that neither agency has taken a clear view on.

What happens to the current stock of bad assets? What proportion of restructured assets will eventually turn bad? Could new schemes like 5/25 loan refinancing—under it banks can extend loan repayment periods up to 25 years, with an option of refinancing the loan every five years—made available for infrastructure projects mask the actual level of stressed assets for another few years?

“.. there is a high chance that loan rescheduling (of operating projects) under flexible structuring schemes may not get captured under stressed assets as they will continue to be classified as performing,” said Fitch in its report even though it said that it expects banks to be more careful in approving such restructuring this time around.

There is also the problem of individual state-owned banks where the proportion of stressed assets is unacceptably high. Indian Overseas Bank (IOB), which reported a gross NPA ratio of 11%, is a case in point.

While IOB’s case is extreme, there are others that have a considerable problem on their hands. For instance, United Bank of India also still has gross NPAs of over 9%. The problems are not restricted to smaller sized banks. At least three of the larger banks—Central Bank of India, Bank of India and Dena Bank—have gross NPAs in excess of 6%.

So while the banking glass (so to speak) may be starting to look half full, it also remains half empty.

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