Banks’ prudential indicators have improved: Fitch report

The operating environment for Indian banks has strengthened as economic risks associated with the covid-19 pandemic have ebbed, Fitch Ratings said in a note on Wednesday.

It said a number of prudential indicators for the sector have also improved compared with pre-pandemic levels, though growing risk appetite in a relatively benign operating environment (OE) highlights importance of buffers against potential stress.

Fitch revised its OE mid-point score for Indian banks to ‘bb’ from ‘bb+’ in March 2020, after assessing that pandemic was likely to worsen existing OE stresses facing the sector.

“India was badly affected by the pandemic, but the associated risks have now receded,” it said, adding that in May it affirmed the sovereign’s rating at ‘BBB-/Stable’ and currently forecasts real GDP growth to average 6.4% annually in the three years to March 2026 (FY23-FY25), putting India among fastest-growing sovereigns in our rated portfolio. According to rating agency, easing of pandemic-related risks has been accompanied by a strengthening of capital buffers. The sector’s average common equity Tier 1 (CET1) capital ratio rose to 13.4% by FY23, from 10.4% in FYE18, partly reflecting around $50 billion in cumulative fresh equity given 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.

“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,” it said.

Regulatory developments since the OE score revision in 2020 have been mixed.

“We believe that the Reserve Bank of India (RBI) has tightened some norms, building on past measures to strengthen governance, improve board oversight and recognize stress,” it said.

For example, regulators revised guidelines for compliance functions in banks in September 2020, and revamped audit rules around rotation of auditors in 2021. The RBI, it said, also announced plans to implement expected credit loss provisioning for banks in FY24 as part of a shift to align with IFRS9 accounting standards, although implementation of IFRS9 for banks has already been delayed by nearly four years. It was introduced for non-bank finance companies in FY19.