The COVID-19 pandemic may set back the recovery of India's banking sector by years, which could hit credit flows and, ultimately, the economy, S&P Global Ratings said on Tuesday.
The US-based rating agency expects non-performing loans in Indian banks will hit a fresh high, raising credit costs, and putting pressure on ratings.
"In our base case, we expect the non-performing loans to shoot up to 13-14 per cent of total loans in the fiscal year ending March 31, 2021, compared with an estimated 8.5 per cent in the previous fiscal year," said S&P Global Ratings credit analyst Deepali Seth-Chhabria.
Moreover, the resolution of these bad-debt situations will likely unfold slowly, which means banks may also be saddled with a huge stock of bad loans next year.
"We assume only about a 100 basis point improvement in non-performing loans in fiscal 2022 (year ending March 31, 2022)," she added.
S&P Global Ratings credit analyst Geeta Chugh said the effect on finance companies will be more pronounced than on banks.
"Some finance companies lend to weaker customers and have high reliance on wholesale funding. These companies were already facing a trust deficit since the 2018 default of Infrastructure Leasing & Financial Services. Finance companies also face accentuated liquidity risks due to high proportion of borrowers opting for loan moratorium, she said.
After years of deterioration, asset quality in the Indian banking system had improved over the past 18 months, helped by higher write-offs, slower accretion of bad loans, and resolution of some big cases under the new bankruptcy law.
Nevertheless, Indian banks were still working through a formidable overhang of non-performing assets when the COVID crisis struck. This largely derailed that rehabilitation process, S&P added.