The coronavirus pandemic could set back the recovery of India's banking sector by years, as lenders face deterioration in credit flows, which will ultimately hit the economy, S&P Global Ratings said in a June 30 report.

The rating agency expects nonperforming loans in the sector to climb 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. Indian lenders' nonperforming loan ratio is also expected to increase by about 50% in the current fiscal year, leading to high credit costs and a further strain on ratings.

After going through multiple aggressive reforms, such as a new bankruptcy law and about a US$30 billion recapitalization of publicly owned banks over the last four years, India's banking sector is expected to face risks from the effects of the coronavirus crisis.

The rating agency also said the slow resolution of bad-debt situations will leave banks with a huge stock of bad loans in the following year. An improvement of only about 100 basis points in nonperforming loans is assumed in the fiscal year ending March 31, 2022.

Meanwhile, the rating agency said the pandemic's impact on finance companies will be more pronounced than on banks because finance companies lend to weaker customers and rely heavily on wholesale funding. Finance companies also face higher liquidity risks due to the high proportion of borrowers opting for loan moratorium.

Ratings projects India's GDP to contract 5% in fiscal 2021, leading to diminished asset quality for Indian financial institutions over the next couple of years.

This S&P Global Market Intelligence news article may contain information about credit ratings issued by S&P Global Ratings, a separately managed division of S&P Global. Descriptions in this news article were not prepared by S&P Global Ratings.