'Poor financials of discoms, source of asset quality risk for Indian banks'

Moody’s Investors Service said the power sector would continue to be a source of asset quality risk for public and private-sector banks in India if the poor financial profiles of state electricity board distribution companies (discoms) do not improve through further structural reforms.

The poor financial health of discoms in India is one of the key factors weighing on the asset quality of the country's banks.

So far, these problems have almost exclusively affected public sector banks, which represent more than 70 per cent of the total banking system assets, and which are directly and indirectly exposed to the credit quality of discoms.

Of all impaired loans at public sector banks, 20 per cent are discom exposures, with the proportion ranging as high as 50 per cent at some of the most exposed banks. In contrast, private sector banks have almost no direct discom exposure.

Moody’s said Government measures taken over the last two years have provided temporary relief to the exposed banks. This included the substitution of some impaired loans with Government obligations and some operational improvements in electricity distribution and in tariffs.

However, Moody’s believes that structural issues have not been fully addressed and that unless more fundamental reforms are undertaken, discoms will continue to pose a threat to banks.

“Worse, if the poor financial profile of discoms is not addressed, it could increase the risk of default by other borrowers in the electricity supply chain, especially power-generating companies which are also creditors of the discoms. In turn, both public- and private-sector banks are exposed to the power generation sector,” the credit rating agency said in its report on 'Indian Banks’ Exposures to State Electricity Board Distribution Companies'.

Meanwhile, Government-owned financial institutions specialised in the provision of funds to the electricity sector, i.e. Power Finance Corporation and Rural Electrification Corporation, remain relatively insulated from the sector’s risks, as they benefit from a number of special protections due to their special status, including an escrow account structure that gives them priority of claim over their borrower’s receivables.