Indian banks are likely to remain less impacted by the rate hikes by the Reserve Bank of India (RBI) since they have been quick to pass on higher rates through loan portfolios but have been slower in raising deposit rates which is boost their net interest margin (NIM), said rating agency Fitch Ratings in a note.
"Banks have been quick to pass on higher rates through loan portfolios, which are mainly floating in nature but have been slower in raising deposit rates. This trend should support a higher NIM, but the lack of competition for deposits may point to relatively muted demand for new credit," Fitch said.
The RBI raised policy interest rates by 50bp to 4.90% in June. Fitch Ratings expects rates to rise further, reaching 5.90% by end-2022 and 6.15% by end-2023, then remaining at this level through 2024.
Mounting repayment pressure for some borrowers amid India’s interest rate hikes, particularly for micro, small and medium-sized enterprises, will test banks’ loan underwriting quality, said the rating agency.
However, Fitch believes asset-quality risks from higher rates should generally be moderate for most banks.
Higher rates will also affect securities valuations and could make it harder for banks to raise fresh capital, particularly at state banks, although wider NIMs will have offsetting positive credit effects.
Aggregate corporate leverage has fallen back in recent years and India has a low level of household debt/nominal GDP, at 14.5% in 2021. Nonetheless, some areas could experience heightened credit stress, the rating agency believes.
The RBI’s June 2022 Financial Stability Report noted that the micro, small and medium-sized enterprise sector has begun to show signs of revival while highlighting that risks still persist.
Fitch expects higher rates to pose particular challenges for this sector and believes that any consequent rise in bank credit costs from asset-quality deterioration could be amplified by the unwinding of regulatory forbearance on Covid-19-affected loans. The unwinding is likely to start from the financial year ending March 2023, assuming authorities do not extend forbearance further.
Fitch-rated Indian banks have relatively large securities portfolios compared with other Asian banking markets, and higher bond yields will cause banks to recognise fair value losses in available-for-sale (AFS) portfolios. However, it is possible that the RBI could reintroduce mechanisms it has used in the past to cushion the impact of rising yields on balance sheet valuations, such as the reclassification of some AFS securities to held-to-maturity or allowing mark-to-market value changes to be spread out over several quarters, Fitch said.
"We expect banks’ capital buffers to remain commensurate with current ratings in the near term, although weaker capitalisation will be a more significant constraint on loan growth at state banks than at private-sector rivals," Fitch said.
"Higher interest rates could make raising additional private capital more challenging, making state banks more reliant on equity injections from the government if they are to maintain market share. We believe state banks will lose market share in the next two to three years due to an inability to raise sufficient capital to match the level of loan growth at private banks. However, this is unlikely to affect bank ratings, as the process will be gradual and we expect large state banks to remain among the largest in India’s banking system over the medium term," the rating agency added.
Disclaimer: The views and recommendations made above are those of the rating agency and not of MintGenie.
