Economic momentum to support improvement in Indian bank asset quality, profitability in 2024: Fitch

Fitch Ratings expects greater divergence in the performance of banking sectors in Asia Pacific (APAC) in 2024, with five countries set to report broadly improving results and three to see deterioration. These outlooks stand in contrast to those leading into 2023, when Fitch projected a broadly stable performance for the vast majority of APAC banking sectors, with only our outlook on Sri Lanka judged to be deteriorating at that time.

The difference in outlooks is particularly marked between banking sectors in APAC emerging markets (EM) and developed markets (DM). All five of the countries where Fitch expect an improving performance are EMs: India, Indonesia, Sri Lanka, Thailand and Vietnam. By contrast, we expect a deteriorating performance in the DMs of Australia and New Zealand, with China the only EM where the outlook is deteriorating.

Banking sector outlooks among many APAC EMs are generally supported by our robust economic growth projections. Growth should buoy loan demand and limit the potential adverse effects on asset quality from interest rates, which we believe have largely peaked across the region. The markets where our (relatively short-term) sector outlooks are improving align well with our view on (longer-term) bank operating environment scores, which are positive in Indonesia and Vietnam, while the score on India was raised in 2023.

China marks an important exception among APAC EMs, with rising system leverage, prolonged property stress, and a shifting policy environment posing downside risks to its banks’ performance. We expect these risks to weigh on Chinese banks’ growth and profitability in 2024, though we expect the largest banks to be less affected than the rest of the system.

A number of risks will be worth watching next year in APAC EMs, despite our view that the overall outlooks are mostly improving or stable. The appropriateness of capital buffers relative to risk appetite could become relevant for some banks’ intrinsic credit profiles – as robust growth, the prospect of rate cuts, and acute competition could lead some to take on more risk to boost earnings. Indonesia stands out as having the highest buffers, both in capital and profitability. Thin capital levels could constrain loan growth for some banks, for example in China, India (particularly state banks) and Vietnam. There is also some risk that the winding-down of loan forbearance and restructuring schemes in markets like China, India, Indonesia, Thailand and Vietnam leads to a faster rise in non-performing loans than we currently assume.

The peaking of the regional interest-rate cycle will tend to affect APAC DM banking sectors more than EMs. Overall loan growth should remain positive, and generally higher than in 2023, for most DMs, but Australia and Japan will be exceptions, with loan growth weaker than the previous year by around 1pp. Net interest margins (NIMs) and non-performing loan (NPL) ratios will come under pressure, but we expect the degree of weakening will generally be modest, with asset-quality deterioration being most marked in Australia and New Zealand.

Fitch’s Sector Outlook for India

The Indian banking system has enjoyed a strong improvement in 2023 that has exceeded Fitch’s expectations. Conditions for banks in 2024 are likely to remain conducive for sustained improvement and growth in business and revenue generation, albeit slightly more moderate than in 2023.

Improved operating conditions and economic momentum, as well as robust credit growth, should broadly support asset quality and profitability. Income levels should continue to benefit from wider margins, high loan growth, and an increase in non-interest income, reasonably offsetting any slight increases in credit costs that might come through as unseasoned loans start to mature.

We expect high loan growth in the near term, but some banks may have to recalibrate their strategy amid rising loan-deposit ratios and tightening liquidity. The retail, farm and SME segments will remain key loan growth drivers, although we expect corporate lending to also sustain robust growth

in the near term. We expect the sector’s improved capitalisation in recent years, aided by improved internal accruals, to support the majority of this growth – but managing risk is pivotal, considering the significant growth in risk appetite across banks, including unsecured retail loans.

What to Watch

Higher Interest Rates: Fitch expects the Reserve Bank of India (RBI) to lower policy rates in 2024. However, any further increase from the current level in a bid to tame inflation in a more resolute manner could be beneficial for NIMs and earnings in the near term. At the same time, a sustained increase in rates could also pose risks to credit demand and asset quality. It would also lead to a faster-than-expected increase in funding costs, while having an impact on bond holdings.

Risk Control and Expected Loss Provisions: Loss-absorption buffers have improved across banks, but effective risk control is important for banks to leverage the current buoyant environment in a sustained manner. RBI is yet to implement expected loss provisions under local accounting for Indian banks, which could pose a risk to loss-absorption buffers if the pace of fresh NPL creation exceeds Fitch’s expectation.

Higher-than-Expected Capital Consumption Due to Rapid Growth: Significantly higher capital consumption due to unsustainably high loan growth would be likely to weigh on the sector’s intrinsic creditworthiness, especially for state banks – as the system has a history of this. Capital augmentation would enhance the cushion against banks’ growing risk appetite but is unlikely to affect the sector outlook.

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