High credit costs hit Indian banks' earnings turnaround

Net interest margins will widen at a snail's pace.

Even as the clean-up of the banking sector’s legacy problem loans approaches its timely end, Indian banking profitability is expected to remain weak as the country’s lenders still grapple with a heavy credit cost burden, according to Moody’s Investors Service. 

Banks in India have been working overtime to clean up their balance sheets and set aside for losses on their stressed assets. As a result, nearly all banks have booked year-end losses in Q4 with the exception of ICICI, Kotak Mahindra, HDFC and Indian Bank.

Net interest margins (NIMs), a common measure of profitability, is thus expected to widen marginally amidst a reduction in nonperforming loans and a strengthening in pricing power as the situation in the debt capital markets makes bank loans more attractive for corporate borrowers.

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The positive development, however, is hampered by high credit costs that is set to weigh in on banking system profitability.

“[L]iquidity constraints at non-bank finance institutions (NBFIs) — increasingly important providers of credit for the economy — will prove a drag on growth. Rising interest rates also represent a risk,” the firm said in a statement.

Public sector banks also continue to display weak capitalisation as they still remain heavily reliant on government capital injections to meet capital requirements. However, strong government assistance is likely to speed up the recovery.

“Capital infusions over the past few years for all public sector banks facing capital shortfalls, as well as other government measures, provide strong support for Moody's assumption of very strong government support for public sector banks,” added Moody’s Investors Service.