Fitch Says Indian Banks Operating Environment Strengthens As Economic Risks Recede

Indian Banks' operating environment has strengthened, said Fitch Ratings on Wednesday, as the economic risks associated with the Covid-19 pandemic have ebbed. Fitch also highlighted several prudential indicators for the sector that have improved compared with pre-pandemic levels. Although, Fitch added that growing risk appetite in a relatively benign OE highlights the importance of appropriate buffers against potential stress.

According to Fitch, the easing of pandemic-related risks has been accompanied by a strengthening of capital buffers.

Indian average common equity Tier 1 (CET1) capital ratio rose to 13.4% by FYE23, from 10.4% in FYE18. Fitch added, "This partly reflects around USD50 billion in cumulative fresh equity provided by the sovereign to state banks since 2015. Earnings buffers also appear significant, with operating profits equivalent to around 2.8% of risk-weighted assets by our estimate in FY23, up from 0.6% in FY20."

Also, Fitch pointed out that India's OE score continues to benefit from the economy's well-diversified structure, which helps to reduce banks' exposure to specific sector-focused shocks.

The large size of the economy and India's favourable demographics should offer banks opportunities to generate profitable business and diversify risk and revenue, as per Fitch.

Further, the rating agency said, "We further expect banks to benefit from the gradual formalization of the SME sector, through initiatives such as the Goods and Services Tax and rapid digitalization (including of payment systems), which will improve the prospects for providing services at acceptable levels of risk to this substantial part of the market."

Earlier, Fitch revised its OE mid-point score for Indian banks to 'bb' from 'bb+' in March 2020, after assessing that the pandemic was likely to worsen the existing OE stresses facing the sector. It added, "India was badly affected by the pandemic, but the associated risks have now receded."

Nevertheless, Fitch has affirmed the sovereign's rating at 'BBB-/Stable' in May. It currently forecasts real GDP growth to average 6.4% annually in the three years to March 2026 (FY23-FY25), putting India among the fastest-growing sovereigns in our rated portfolio.

While concluding, Fitch said, " We expect some normalisation in FY24, although credit demand has remained robust in 1QFY24. However, rapid loan growth and higher exposure to certain asset classes are also likely to indicate greater risk appetite, amid stiff competition, which could raise the sectoral risk if not managed carefully. India's private credit/GDP, at around 57% in 2022, is already moderately higher than the median for sovereigns in the 'BBB' category, of 50%."