Indian banks' improved performance for the financial year ended March 2021 (FY21) is in contrast to stress evident from extension of Covid-19 related relief measures to borrowers, Fitch Ratings said in a report released on Wednesday.
Private banks' considerably better performance than state banks has positively influenced banking system aggregates in addition to deferred recognition of stressed assets that has masked the stress.
The banking sector's average impaired loans ratio declined to 7.5 per cent in FYE21 from 8.5 per cent at FYE20 while banks simultaneously extended relief to stressed borrowers affected by Covid-19 pandemic, said the report.
The government's announcement on June 28 that it will increase limit of emergency credit line to USD60 billion from USD40 million to support micro, small and medium enterprises underscores the challenges posed by the more virulent second wave of infections in 1Q FY22 on the most vulnerable sectors in the economy.
It has affected the pace of economic recovery with Fitch revising down its real GDP growth outlook for FY22 to 10 per cent from 12.8 per cent.
Fitch said the operating environment remains challenging for banks with limited opportunities for business and revenue growth. Problems can escalate in the event that successive Covid-19 waves and lockdowns prevent a meaningful economic recovery considering that India's full vaccination rate is still quite low.
Fitch expects banks to manage the near-term balance sheet pressures on the extended relief -- as they did in FY21 -- but there are also risks to their capital and earnings buffers from a protracted asset-quality cycle.
"We believe state banks are more at risk given their average common equity tier 1 is around 600 basis points lower than that of private banks while the latter's average return on assets is four times higher than state banks."