MOODY'S OUTLOOK FOR BANKS STABLE, BUT SEES RISKS OF ASSET BUBBLES

Moody's outlook for the country's banking system continues to be ‘stable' but the investment consultancy sees “an increased risk of probable asset bubbles forming and posing a medium-to-longer-term challenge for the banking system.”

In its banking system outlook, released worldwide, Moody's Investor Service said the stable outlook is forecast over the next 12-18 months based on “favourable operating conditions, solid capital levels, a strong retail deposit funding base and sound liquidity.” But, it said, these “positive factors are balanced by the need to manage the accelerating pace of loan growth and recent asset quality challenges, particularly consumer lending.”

Risks

Stating that the operating milieu for Indian banks is likely to remain favourable to high credit growth with GDP growth trending back up to its pre-debt-crisis level of close to 9 per cent year, Moody's, however, hedged this against “potential downside risks emanating from still-high levels of inflation.” This is further pronounced by the risks “of an overheating economy, including the probable formation of asset bubbles, given our expectation of continued strong economic and credit growth, while real estate prices in metropolitan areas and equity markets have already recaptured their pre-crisis peaks.”

Still, Moody's observed that “regulatory limits on Indian banks' exposure to sensitive sectors, including capital markets, somewhat temper our concerns, as does our view that the asset quality pressures faced by Indian banks over the past two years will moderate.” It foresees asset quality to improve in the next year as industrial companies return to utilising their full capacity.

Pointing out that the moderate deterioration in asset quality in the past two years reflected reduced demand for Indian exports and higher delinquencies on unsecured personal loans, it said, “importantly, we expect loans that were restructured during the past two years to perform relatively well, as their track record so far suggests minimal slippages into problematic status.”

Fresh equity

Although Moody's analysis shows that the system is “resilient and that banks have the buffers to absorb the envisaged losses,” it cautioned that Indian banks do have high loan concentrations relative to their equity base and this “systemic vulnerability is unlikely to change significantly.” Even while the banking system is generally well capitalised, Moody's expect the Indian Government to continue infusing fresh equity into public sector banks as part of its recapitalisation plan. Private sector banks have sufficient capital to grow at above system average rates over the next one to two years, it noted.

It said one of the Indian banking system's strengths is its favourable funding profile, driven mainly by retail customer deposits and a minimal reliance on wholesale funding which provides stability to the banks. Banks also have sizeable Government securities portfolios which are available to obtain immediate liquidity from the RBI through repurchase transactions. These holdings, it said, provide the capacity to handle occasional and transient tight local currency liquidity conditions arising out of material corporate payments.

Moody's expect overall banking profitability to grow in the coming quarters. Recurring earnings, especially for public sector banks, are likely to remain highly dependent on net-interest income in view of the traditional banking model followed in India. Private sector banks have more earnings diversification, with high fee income relative to PSBs. Net interest margins are likely to benefit from India's currently rising interest rate regime, reflecting positively on Indian banks' profitability signs.

M&As

Moody's does not foresee merger and acquisition (M&A) activity among PSBs over the short to medium term, with the exception of the SBI group. “Extracting efficiencies and rationalising through cost-cutting among merged PSBs would be hard to achieve, given the political difficulty in closing branches and laying-off employees

While Moody's expect the Indian regulatory and supervisory structure in banking industry to be fine-tuned in the coming years to reinforce the financial stability framework, it said implementation of the advanced approaches to capital adequacy and the supervisory review and evaluation process under Pillar 2 of the Basel II would “mildly challenge Indian banks in terms of data, systems, technology and skilled human resources and particularly PSBs.”

SOURCE: http://www.thehindubusinessline.com/2010/12/17/stories/2010121753791000.htm