Indian financial institutions have strong capital buffers that will help them weather global economic uncertainties caused by inflation and the war in Ukraine, according to the nation's central bank.
Stress tests by the Reserve Bank of India show that the aggregate gross nonperforming loans in the country's banking system may fall to 5.3% by March 2023 under its baseline scenario, declining further from a six-year low of 5.9% in March 2022. The central bank expects the fall to be driven by higher bank credit growth and the declining trend in the stock of bad assets.
Only medium or severe stress could push aggregate nonperforming assets higher, the central bank said in its Financial Stability Report published June 30.
"[Indian] banks have made substantial provisions on legacy weak loans and pandemic-related weak loans are not significant," Nikita Anand, associate director at S&P Global Ratings said. "India's good economic growth prospects should also support a recovery of the banking sector."
Recession fears
While inflation and rising rates pose risks to the economy, Anand agreed with the central bank's assessment that the banking system's weak loans have peaked and should decline. Still, macroeconomic risks could dampen credit demand and affect low-income borrowers and small and medium-sized enterprises that are still struggling to recover from the pandemic, Anand said.
Recession fears have roiled global markets as Russia's war with Ukraine drags on, sending the prices of commodities, ranging from wheat to crude oil, surging earlier this year. Major central banks, including the U.S. Federal Reserve, have had to hike rates at an accelerated pace to tamp inflation. Though commodity prices have begun easing, many analysts fear that rapidly raising rates when the global economy was still recovering from the COVID-19 pandemic could stall growth.
The Reserve Bank of India said the financial stability risks to the Indian economy are "skewed towards global spillovers and geopolitical tensions." The central bank pointed out that monetary policy normalization in response to high inflation is causing volatility in the financial markets. "This is very challenging to emerging market economies that face rising indebtedness, currency depreciations and reserve losses," the central bank said.
Defaults manageable
Defaults by companies may rise as relief measures announced during the COVID-19 pandemic are scaled back, CRISIL, a unit of S&P Global, said in a July 5 report. The annual default rate stood at 2.2% for fiscal 2022, nearly half the 4.1% average of the past decade, CRISIL said. The annual default rate for companies in the sub-investment grade category, which are dominated by micro, small and medium enterprises, rose to 5.24% in the fiscal year ended March 31, 2022, from 3.90% in the previous year.
While banks may see an uptick in bad loans from the small-scale industry, retail nonperforming assets are "not expected to show any material change," said Krishnan Sitaraman, senior director at CRISIL.
"Banks are carrying healthy countercyclical provision buffers, which could be utilized to write off sticky retail [nonperforming assets] and thus bring down overall [nonperforming assets]," Anand Dama, senior research analyst at Emkay Global Financial Services, told Market Intelligence. Fresh stress from the SME sector could also be limited and looks manageable, Dama said.
The Reserve Bank of India's stress tests also showed that banks would be able to comply with minimum capital requirements even under stress scenarios. Under the central bank's baseline scenario, the aggregate capital ratio of 46 major banks may slip to 15% by March 2023 from 16.5% in March 2022. Even under a severe stress scenario, the ratio may decline to 13.3% by March 2023, with none of the 46 lenders breaching the minimum capital requirement of 9%.