India’s economic recovery reduces the risk of a sharp deterioration in public sector banks’ mildly improving asset quality, according to Moody’s Investors Service.

However, capital shortfalls will remain despite a likely government equity infusion, leaving banks vulnerable to unexpected shocks and restricting credit growth, it cautioned in a note.

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“Various measures by the Indian government to support borrowers have helped curb growth in public sector banks’ non-performing loans (NPLs), and the volume of restructured loans is not as large as we anticipated,” said Rebaca Tan, Assistant Vice-President and Analyst.

Profitability remains weak

The global credit rating agency observed that the asset quality at the five largest rated public sector banks (PSBs) in India — State Bank of India, Bank of Baroda, Punjab National Bank, Canara Bank, and Union Bank of India — improved mildly in the first nine months of the year ending March 2021 (fiscal 2021) despite an economic contraction exacerbated by the pandemic.

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As per Moody’s assessment, the gross NPL ratios of the five banks declined by an average of about 100 basis points as of end of 2020 from a year earlier, even including loans that have become delinquent since the end of August 2020 but are not formally classified as NPLs because of a pending case in the Supreme Court.

However, India’s public sector banks will continue to face capital shortages as their profitability remains weak given high credit costs, leaving them vulnerable to any unexpected stress, it added.

The government plans to infuse ₹20,000 crore in equity capital into public sector banks in fiscal 2022, on top of the ₹20,000 crore budgeted in fiscal 2021.

“While the government’s capital infusion into public sector banks will help them meet Basel capital requirements, it will not boost credit growth,” Tan said.

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