11 public sector banks are under the prompt corrective action framework by the RBI because of their weak capital ratios and high non-performing assets or loans.
Moody's Investors Service said that the Reserve Bank of India's (RBI) push banks to recognize problem assets more accurately will reduce profitability of banks in the near term. This will, however, produce benefits over the longer term.
"Increased provisioning will hurt the banks' profitability, and weaker public sector banks (PSBs) in particular will continue to report losses in the next fiscal year (FY19), adding pressure on their capital ratios," said Alka Anbarasu, Vice President and Senior Analyst with Moody's.
The observations were made in its report, "Banks -- India: A final push for NPL recognition will hurt profitability in coming quarters".
Already, 11 public sector banks are under PCA or prompt corrective action framework by the RBI because of their weak capital ratios and high non-performing assets or loans (NPAs or NPLs).
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"Nevertheless, the near-term impact of this profitability deterioration on their credit profiles will be largely offset by planned capital infusions from the government," she added.
In October 2017, the government announced infusion of an unprecedented Rs 2.11 lakh crore capital over two years in PSBs that are reeling under high NPAs. Of these, Rs 80,000 crore has already been sanctioned in the last fiscal year ending March 2018.
Banks have been struggling to resolve NPAs worth over Rs 8.5 lakh crore.
Moreover, Moody's said that the central bank's new NPA resolution rules are positive from the point of view of healthy quality of the balance sheet because they provide a clearer, time-bound process for resolving stressed assets and will prevent a future buildup of problem loans in the system.
Under the new rules for bad debt resolution that the RBI released on February 12, banks can no longer resort to various loan restructuring schemes to delay the recognition of NPAs.
Anbarasu says "Also, we have already been taking into account the system's restructured assets, not just NPAs, when assessing the banks' credit profiles, so shifts in the composition of the broader asset pool will not have much bearing on our assessment of the banks' asset quality."
Although banks have recognized many loans as NPAs following an extensive inspection of loan books by the RBI in 2015, they still hold large volumes of restructured loans, a large share of which will become NPAs in the coming quarters. As banks reclassify these assets, NPA ratios will gradually rise, but once this process is complete, they will stabilize and eventually decline substantially, the Moody's report said.
"Among the rated private sector banks, ICICI Bank Limited (Baa3 stable, ba1) and AXIS Bank Limited (Baa3 stable, ba1) have the highest ratio of stressed assets but are better equipped to face higher credit costs because their profitability is superior -- and so is their capitalization as a result," the report adds.
Most of the existing restructured assets are legacy loans originated in 2009-12, largely to infrastructure-related sectors, such as construction and power, and Moody's expects growth in new stressed assets to be limited.
The power sector accounts for more than half of stressed assets, as it continues to struggle with a low capacity utilization rate, with state-owned power distribution companies remaining under stress and holding off on entering into long-term purchasing agreements with electricity generators.