Indian private banks, which have stronger loss-absorption buffers than the public sector banks, are likely to gain market share from their state-owned peers in the medium term, says Fitch Ratings.

In a note, the ratings agency says, “Private banks’ loss absorption buffers, in particular enhanced capital bases, strengthen their ability to recognise losses up-front with less disruption in their efforts to accelerate market-share gains.

However, we do not expect immediate gains as the sector’s credit growth is likely to remain subdued, and will only resume meaningfully once a sustained recovery from the pandemic gets underway.”

Indian private banks have had a decade of strong growth, reflected in much higher loan compounded annual growth rate (CAGR) of 19.6% compared with state-run banks’ 8.5%, backed by better capitalisation and fewer asset quality problems. 

Private banks increased their market shares by 14.4 percentage points (pp) and 18.5pp by assets and loans, respectively, at the expense of state-owned counterparts during this time.

According to Fitch, most of the gains occurred in the five years preceding the coronavirus pandemic as state banks were hamstrung by ballooning impaired loans, larger losses and weaker capitalisation. 

Nonetheless, it says, “private banks’ risk appetite in some sectors has been significant during this time, which has contributed to the downward trajectory in their viability ratings (VRs) in the last two years. Their larger risk appetites in certain segments render their intrinsic credit profiles more vulnerable to deterioration in the operating environment, such as what we see now.”

The government-led merger of state-owned banks helped them to consolidate their market positions in the last few years, however, Fitcy says, the state-owned banks’ market shares will continue to erode if they do not raise adequate capital to absorb future stress and support growth.

Some Indian banks have raised capital after the Reserve Bank of India (RBI) implored banks to raise fresh equity. However, the capital-raising has been limited thus far to private banks, which collectively raised $6.3 billion in the past three months. 

“While state banks have announced their intentions to raise fresh equity, they have not gone further than routine board approvals nor given clear indications on the timelines, except for a few banks. This is despite the need to expedite improvement in the state banks’ capital positions, which we believe remain vulnerable to varying degrees to future stress and unexpected losses,” the ratings agency says.

State banks’ capital positions weakened during the quarter ended June 2020 (1QFY21) mainly due to the adverse impact of $4.4 billion from mergers on the acquiring state banks, which eroded common equity tier 1 (CET1) ratios by an average of around 170bp. At the same time, private banks added 165-220bp to their CET1 ratios, which averaged at 14.8% at FYE20. As a result, the gap between private banks’ and state banks’ CET1 ratios widened to 637bp from 474bp at end-December 2020.

Without adequate capital, Fitch says, state banks may be forced to curtail growth because their financial statements do not yet fully reflect the impact of the pandemic on asset quality due to regulatory relief measures that have delayed non-performing loan (NPL) recognition.

This gap between reported financials and economic reality is reflected in the sector’s declining impaired loan ratio of 8.4% at the end of 1QFY21 (FYE20: 8.5%), which was mainly driven by a 75% yoy decline in new NPLs and aggressive write-offs, the ratings agency says, adding credit growth, however, was negative (-1.4% for 1QFY21), reflecting the prevailing risk aversion amid heightened stress in the banking system. 

Fitch says it believes that the moderate recovery in banks’ return on assets to 0.50%, from 0.20% at FYE20, is not sustainable in the foreseeable future, as NPLs will start to increase in 3QFY21, which will mostly affect those banks with weaker capitalisation by further pressuring their intrinsic creditworthiness.

The ratings agency says it took rating action on several banks’ VRs in early May 2020 and is likely to review them again towards end-2020. It sees, state-owned banks’ VRs would remain under further rating pressure if the capital positions of individual banks are not sufficient to withstand the negative effects of the pandemic on asset quality and growth. 

Indian banks’ IDRs are support-driven and are therefore anchored to India’s sovereign rating of BBB- with negative outlook. 

Fitch’s earlier report in July 2020 estimated that Indian banks will require between $15 billion and $58 billion in fresh equity over the next years under various stress scenarios, with the bulk of it required by the state-owned banks.