Moody’s downgraded the outlook for Indian banks from Stable to Negative. This downgrade assumes significance as it comes at a stage when markets are already under pressure and financials account for 41% of the Nifty weight. What is the reason for the downgrade?
Weak Operating environment
Moody’s has highlighted this as the single biggest risk for the Indian banks. The lockdown following the COVID-19 has led to a virtual halt in economic activity. EMIs have been postponed but it is likely to create cash flow problems for banks. The immediate impact will be that credit will virtually dry up and that is likely to have a direct impact on GDP growth. The lockdown will also impact the incomes and purchasing power of Indian households and that could have larger repercussions for the long term consumption story. In this background, Indian banks could see more defaults.
Asset quality risk
The lockdown is likely to result in a higher risk of defaults in SME loans and also in retail loans. That is where most of the private banks have the largest exposure. In fact, realty and consumer lending account for 30-40% of most private banks. That could come under tremendous pressure. Even the EMI moratorium scheme is likely to create short term cash flow mismatch for the banks and impair assets in the future.
Profits and capital efficiency
One of the factors that distinguished the private banks from the PSU banks is the focus on profitability and ROE. Moody’s opines that the comfort zone could now change drastically as most private banks could come under profit pressure due to rising incidence of asset impairment. Most private banks have had easy access to funds; both debt and equity. With stressed financials, we could have a situation wherein, some private banks could see capital getting depleted by losses and the cost of funding going up sharply. That could impact the capital raising ability of the banks to a great extent. Higher credit costs and lower revenues will apparently crimp profits.
Pressure on the government
In the last few years, the government has consistently intervened and bailed out the PSU banks. But with the fiscal deficit set to go higher, further support in terms of capital infusion will be limited. Any future cases like Yes Bank may find it hard to get a willing buyer to bail them out if the situation worsens from this point. Loss of government support remains a major risk for Indian banks. In the future, depositor bailouts may not be feasible for the Indian government. At best, it may be partial and calibrated. Moody’s appears to be justified in believing that Indian banks could be entering a new phase where valuations could come under real pressure.
