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Indian bank earnings growth to hinge on economic recovery after forbearance ends

Forbearance measures helped Indian banks report stronger earnings in the December quarter, though sustaining that performance will depend on government policies and the recovery of the local economy from its worst showing in several decades, analysts say.

State Bank of India, HDFC Bank Ltd. and ICICI Bank Ltd reported quarter-over-quarter increases in net income for the fiscal quarter ended Dec. 31, 2020. State Bank of India's net income increased to 51.96 billion rupees from 45.74 billion rupees in the previous quarter, but down from 55.83 billion rupees in the prior-year period. HDFC Bank and ICICI Bank's net income for the quarter were also an increase from their previous quarter and prior-year net income. Bank of Baroda swung to profit in the quarter, reporting a net profit of 10.61 billion rupees, compared with a net loss of 14.07 billion rupees in the prior-year period.

The improvement in the banks' net income was driven by various support measures such as a six-month moratorium on loan repayments, a court order barring banks and finance companies from declaring any asset as nonperforming and a one-time loan restructuring window, Nikita Anand, the associate director for credit risk in emerging markets at S&P Global Ratings said in an e-mail. That gave banks more time to recover money from weaker borrowers or restructure loans, Anand said.

"The sustainability of these improvements will be tested over the next few quarters and hinges on economic recovery," Anand said.

The $2.83 trillion economy slipped into its first recorded recession amid the COVID-19 pandemic and is projected by the government to contract 7.7% in the fiscal year that ends in March. However the government also points to a recent sharp rebound and the International Monetary Fund expects India's GDP to grow 11.5% this year.

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Softer blow

"The blow from the pandemic is not as significant as we had expected. The volume of restructured loans so far has also been lower than our initial estimates" even if the effects of a court order asking banks to not declare new nonperforming loans after Aug. 31 are excluded, Anand said.

India's Supreme Court said in September last year that accounts that were not declared NPA till Aug. 31 will not be classified as nonperforming until the court's further orders.

The ruling helped banks' nonperforming levels come down, said Krishnan Sitaraman, senior director at CRISIL, a unit of S&P Global. "We should also see NPAs increase after the Supreme Court standstill order on recognition of NPAs is vacated," he said.

Stress tests by the Reserve Bank of India indicate that the gross NPA ratio of the country's banking system could rise to 13.5% by September from 7.5% in the prior year. If the macroeconomic environment worsens into a severe stress scenario, the ratio could surge to 14.8%.

Earlier this month, Finance Minister Nirmala Sitharaman announced higher government spending and stable taxes in the government's budget for the fiscal year starting April 1. She allowed herself greater policy space by projecting a higher fiscal deficit in the current fiscal year, and tolerance for a deviation from targets in the coming years to support the economy's recovery from the pandemic.

Emergency medicine

Still, the flagship annual financial document of the government released ahead of the budget underscored the importance of treating forbearance measures as temporary and to be withdrawn once economic recovery takes hold. "Caution must be exercised so that emergency medicine does not become a staple diet because borrowers and banks can easily get addicted to such palliatives," the government's Economic Survey report said.

Delay in withdrawing the forbearance measures announced during the 2008 global financial crisis was partly responsible for the recent crisis in India's banking industry, the report said. Banks restructured loans even for unviable companies and reported inflated profits that were used to pay increased dividends to shareholders. That led to banks becoming "severely undercapitalized" and the distorted incentives damaged the quality of investment in the economy, according to the report.

CRISIL's Sitaraman noted that a number of banks have already raised capital which has enhanced their capital adequacy ratios and strengthened their balance sheets. "Banks have also increased their provisioning levels to enhance their cushion against future impact on their balance sheets from NPAs," he added.

The Reserve Bank of India expects banks' capital ratios to drop to 14.0% in September from 15.6% in September 2020. The central bank warned that it may worsen to 12.5% in a severe stress scenario, under which nine banks may fall short of meeting the minimum capital requirement.

While many private sector banks and top-tier state-run lenders have relatively comfortable capitalization and many of them have already raised capital over the last 12 months, the smaller government-owned banks may need capital for growth, Anand said.