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Forbearance to stressed sectors likely to defer asset quality pressures: Fitch Ratings

FE Bureau
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The Reserve Bank of India's announcement on February 6 to show forbearance towards stressed sectors, including micro, small and medium-sized enterprises (MSMEs) and real estate, signifies a gradual shift from the regulator’s earlier effort to enhance the quality and transparency of asset classification in the Indian banking system, said Fitch Ratings on Monday. The move is likely to defer asset quality pressures unless there is sustained improvement in macroeconomic conditions, the ratings agency said.

Allowing a one-time restructuring of loans to MSMEs and the announced relaxation in asset classification for certain real estate projects mark a further dilution of the RBI’s drive to enhance loan recognition. Such regulatory forbearance carries the risk of perpetuating moral hazard, as it follows aggressive lending growth and risk-taking in certain sectors in the five years to FY19, it said.

The ratings agency said Indian banks had a "poor record" with restructuring, given that the RBI's asset quality reviews in FY16 and FY18 had found that a dominant share of loans restructured after FY12 had degraded into non-performing assets. "It is unclear whether the latest announcement marks a substantial shift in the RBI’s policy approach. Nevertheless, it is not surprising in the current weak operating environment and is in line with a recent trend to weaken asset recognition standards," it added.

The probability of the RBI extending the forbearance to non-banking financial institutions as well is high, considering the impact that the liquidity squeeze in the sector and a slowing economy, the agency said.

The ratings agency said the RBI's move to allow banks to knock off the equivalent of additional loans disbursed to auto, housing and MSME sector between end-January and end-July 2020 from their net demand and time liabilities for the purpose of calculating their cash reserve ratio (CRR) would improve monetary transmission, and support credit to fields that have multiplier effects within the wider economy.

"However, most of these sectors have had above-average lending growth in the last few years, either directly or indirectly via non-banks, and could be at risk were the economy to slow. Moreover, these measures are unlikely to support sustainable credit growth until capitalisation improves meaningfully across banks, in particular among state-owned banks, which account for nearly two-thirds of the sector’s assets," the agency said.