Economic risks in banks increases after demonetisation, says S&P Global ratings

Economic risks faced by banks in India have increased amid deteriorating credit profile of corporates, while demonetisation could hurt lenders’ asset quality in the short-term, S&P Global Ratings said on Thursday.

It said while the demonetisation of 500 and 1,000 rupee notes would be positive in long-term, it will have a transitory impact on growth in the short-term and could hurt banks’ asset quality.

“Bank deposits would benefit due to demonetisation, though not all inflows will remain in the banking system on a permanent basis,” S&P said in a report titled ‘Banking Industry Country Risk Assessment: India’.

“The economic risks facing financial institutions in India have increased amid structural and cyclical challenges that Indian companies face,” it added.

The global ratings agency said the credit quality of Indian companies has deteriorated sharply in the past few years amid tepid domestic industrial activity, weak commodity prices, project execution woes, subdued profitability and high leverage in some pockets.

In particular, the metal and infrastructure sector had 34.4 per cent and 16.7 per cent stressed loans respectively till March 2016.

S&P, however, retained the ratings on all financial institutions in India because it expects these entities to remain capitalised in-line with their existing stand-alone credit profiles and ratings.

Despite increased economic risks, the banking sector remains in group ‘5’ under S&P’s Banking Industry Country Risk Assessment. Other countries in the group include China, South Africa, Spain, Trinidad and Tobago, Bermuda, Poland, Panama, Peru and United Arab Emirates.

S&P said India’s low-income economy constrains its economic resilience. “We expect GDP per capita to remain low at USD 1,703 by the end of March 2017,” it added.

However, improvements in policymaking continue to boost the medium-term prospects for India’s economic and fiscal performance, S&P said, adding India’s growth has outperformed its peers.

It said in terms of industry risk, Indian banks benefit from high levels of stable core customer deposits, which limit dependence on external borrowings.

“The banking system’s good franchise, extensive branch networks, and large domestic savings support the deposit base.  We expect efficient banks with higher profitability, capitalisation and a focus on digital banking to gain market share over others,” it added.

S&P said while improvements in policymaking have raised prospects for a stronger economic and fiscal performance, a material improvement in asset quality will require a further pick up in industrial demand, deleveraging of corporate balance sheets, resolution of problems in stressed sectors, and further pass-through of lower interest rates to borrowers.

“We expect risk from economic imbalances to be low in the next 12 months,” it added.