The operating environment (OE) for Indian banks has seen a notable improvement as the economic risks linked to the COVID-19 pandemic have diminished, according to a recent note from Fitch Ratings. The rating agency highlighted that several prudential indicators for the banking sector have shown positive changes when compared to the pre-pandemic levels. However, Fitch also pointed out that the increasing risk appetite in the relatively favorable OE underscores the importance of having sufficient buffers in place to counter potential stress.
In March 2020, Fitch had revised the mid-point score for Indian banks’ OE to ‘bb’ from ‘bb+’ as it assessed that the pandemic was likely to exacerbate the pre-existing stresses faced by the sector. The note highlighted that while India experienced significant negative impacts due to the pandemic, the associated risks have now receded. Fitch’s rating for India’s sovereign (‘BBB-/Stable’) was affirmed in May, and the agency currently predicts that the country’s real GDP growth will average around 6.4% annually over the three years ending in March 2026.
One positive development is the strengthening of capital buffers within the banking sector. The average common equity Tier 1 (CET1) capital ratio for the sector increased to 13.4% by the fiscal year ending in 2023, up from 10.4% in FYE18. This growth in capital partly reflects the sovereign providing state banks with approximately $50 billion in cumulative fresh equity since 2015.
Moreover, earnings buffers also appear substantial, with operating profits accounting for around 2.8% of risk-weighted assets in FY23, a significant rise from 0.6% in FY20. Fitch noted that India’s diverse economic structure helps mitigate banks’ exposure to shocks specific to certain sectors. The country’s sizable economy and favorable demographics provide banks with opportunities to generate profitable business while diversifying risk and revenue streams.
Fitch highlighted that regulatory developments since the OE score revision in 2020 have been mixed. The Reserve Bank of India (RBI) has implemented certain measures to enhance governance, strengthen board oversight, and acknowledge stress. For instance, regulatory guidelines for compliance functions in banks were revised in September 2020, and audit rules regarding auditor rotation were revamped in 2021. The RBI also announced plans to adopt expected credit loss provisioning for banks in FY24 as part of an alignment with IFRS9 accounting standards. It’s worth noting that the implementation of IFRS9 for banks has faced nearly a four-year delay, having been introduced for non-bank finance companies in FY19.
