'Coronavirus fallout will leave banks with capital shortages again' — Moody's warns

A sharp slowdown in India's economic growth induced by the coronavirus outbreak will hurt the public sector banks' (PSBs) asset quality and profitability, Moody's Investors Service said in a report on Friday.

Consequently, the PSBs' already weak capital buffers will be depleted, said Moody's Investors Service report on the Indian public sector banks titled "Coronavirus fallout will leave banks with capital shortages again".

"We estimate PSBs will need INR 1.9 trillion-INR 2.1 trillion ($25 billion-$28 billion) in external capital over the next two years to restore their loss absorbing buffers," the report said.

"The most likely source of capital to plug the capital shortfalls will be government support, despite the completion of a large recapitalisation by the government several months ago."

Accordingly, the report predicts that PSBs' asset quality will deteriorate, led by retail and small business loans.

"We expect the Indian economy will contract sharply in fiscal year ending March 2021 (fiscal 2020) before returning to growth, though modestly, in fiscal 2021. As a result, formation of new nonperforming loans (NPLs) will accelerate substantially, driven by the retail and micro, small and medium enterprises (MSME) segments," said the report.

"Although one-time loan restructuring allowed by the Reserve Bank of India (RBI) will prevent a sudden increase in NPLs, NPLs and credit costs will increase in the next two years, hurting PSBs' already weak profitability and depleting their capitalisation."

According to the report, the PSBs will face large capital shortfalls again as credit costs rise.

"Under our base scenario, we estimate PSBs in the aggregate will need external capital of about INR 1.9 trillion-2 trillion in the next two years. Of the total amount, PSBs will need about INR 1 trillion to build loan-loss provisions to about 70 per cent of NPLs, which will leave them with enough capacity to grow loans 8-10 per cent annually, faster than the 4 per cent in fiscal 2020," the report said.

"With a capital infusion of this magnitude, banks would also be able to maintain capitalisation at levels comparable to those of similarly rated peers globally, with Common Equity Tier 1 (CET1) ratios of at least 10 per cent."

As per the report, to maintain financial stability the government will continue to provide capital support for PSBs.

"Uncertainty surrounding India's economic recovery as well as the ongoing cleanup of balance sheets are making it difficult for most PSBs to raise equity capital from markets. This means PSBs will continue to need support from the government to plug their capital shortfalls, and we expect the government to infuse fresh funds into them as it has done in the past," it said.

"If PSBs, which dominate the banking system in India, fail to function properly in the absence of state capital support, the country will face a deepening credit crunch, hampering its economic recovery."

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