Moody's changes outlook for Indian banking to 'negative'

The Moody's report said that banks' asset quality will deteriorate across the corporate, small and medium enterprises and retail segments, leading to pressure on profitability and capital.

While funding and liquidity at public sector banks (PSBs) will be stable, growing risk aversion in the system following a default by a private sector bank will increase funding and liquidity pressure on small private sector lenders, it said.

"We have changed the outlook for the Indian banking system to negative from stable. Disruptions to economic activity from the coronavirus outbreak will exacerbate a slowdown in India's economic growth,a it said.

According to Moody's, a deterioration of global economic conditions and a 21-day lockdown imposed by the Indian government in an effort to slow the spread of coronavirus will weigh on domestic demand and private investment.

Further, it said, "credit supply to the economy will be hampered by volatility in global financial markets and heightened risk aversion among Indian banks and debt market participations after a default by privately owned Yes Bank Limited (Yes Bank, Caa1 positive, ca)."

Stress among non-bank finance institutions will also curtail their capacity to lend and these factors will further hinder India's economic growth, which already had been weakening prior to the coronavirus outbreak, the report noted.

A sharp decline in economic activity and a rise in unemployment will lead to a deterioration of household and corporate finances, which in turn will result in increases in delinquencies, it said.

Growing solvency stress among non-bank financial institutions will also increase risks to banks' asset quality because banks have large exposures to the sector.

If the government makes more capital infusions into public sector banks, as it has in the past few years, it will mitigate capital pressure for them, according to the Moody's report.

"However, the government so far has not announced any new plan to provide capital support for PSBs. Most rated private sector banks will maintain strong capital buffers."

It said that funding and liquidity at PSBs will be stable because public trust in them will remain strong thanks to sovereign backing, unaffected by the Yes Bank default.

Funding and liquidity at large private sector banks will also be stable, given their well-established franchises and strong depositor bases.

However, the default of Yes Bank will lead to risk aversion among depositors and creditors, creating funding and liquidity challenges for smaller private sector banks with weaker franchises.

Government support for PSBs will remain strong, which will contain the risk of any contagion of their balance sheet weakness to the system.

"By contrast, the Yes Bank default indicates the government will not provide support a failing private sector banks without imposing a moratorium on depositors and creditors, although government support will mitigate losses to depositors and senior creditors after the failure," it added.