RBI unfazed by Moody's downgrade

• Image Credit: Bloomberg
• The Reserve Bank of India headquarters in Mumbai. The RBI report counters Moody’s downgrade rationale.

source : Babu Das Augustine, Deputy Business Editor :Gulf news : December 5, 2011

Dubai: Ratings agency Moody's Investor Services recently downgraded the outlook of India's banking system from "stable" to "negative", triggering a sharp reaction on stock markets.

But the Reserve Bank of India (RBI) believes that some of the concerns were misplaced and banks are doing fine despite the domestic and global econ-omic uncertainties.

According to the RBI's latest publication Report on Trends and Progress in Banking, the net interest margins (NIM) and return on assets of Indian banks increased in 2010-11 in the face of rising interest rates.

Banks' growth in "other income" (trading, fee income, etc) fell in 2010-11, but the rise in NIM more than compensated for this.

Return on assets (RoA) for all banks rose to 1.1 per cent above the one per cent global benchmark for good performance in banking.

Moody's downgraded its outlook for the banks from "stable" to "negative" over concerns that an increasingly challenging operating environment will adversely affect asset quality, capitalisation and profitability.

Mounting obstacles

The downgrade came at a time when the Indian banks were facing mounting obstacles such as persistently high inflation, high interest rates driven by the central bank's inflation targeting that saw repo rates increasing 13 times since March, and customers who risk default because of those high interest rates.

The domestic concerns were compounded by dismal economic conditions in the West.

"India's economic mom-entum is slowing because of high inflation, monetary tightening, and rapidly rising interest rates. At the same time, concerns have emerged over the sustainability of the recovery in the US and Europe, and the rise in the borrowing programme of the Indian government, which could drain funds away from the private credit market," said Moody's vice-president and senior analyst Vineet Gupta.

The RBI report counters Moody's rationale and highlights that the Indian banking system is healthy enough to withstand the deteriorating domestic and international economic conditions.

Capital adequacy for banks as a whole in the country is at 14.2 per cent under Basel-II norms and for public sector banks, it is a little lower, at 13.1 per cent because of the lower equity capital they have.

Moody's had pointed out lower capitalisation levels as one of the reasons for its recent downgrade.

In the case of government owned banks, lower capitalisation is not a big issue as it is a matter of sovereign decision to hike the capital levels, and the government support is implied by the ownership structure.

"We believe that Indian banks are well capitalised and the underlying economy is growing at 7-8 per cent, which reflects that fundamentals of economy remain strong," said Rajesh Mokashi, deputy managing director, Credit Analysis and Research Ltd (Care). "Our outlook on the Indian banking sector remains comfortable."

In contrast to Moody's downgrade, Standard & Poor's (S&P) Ratings Services recently revised upwards India's banking industry country risk assessment (Bicra) to group ‘5' from group ‘6', making it part of a group of countries including China, Portugal, Thailand and Turkey, it said.

"India's banking system has a high level of stable, core customer deposits, which limit dependence on external borrowings...the government is likely to provide timely financial support to the banking system, if needed," it said.

"In our view, banking regulations in India are in line with international standards and the regulator has a moderately successful track record," S&P said.

The big concern in the Indian banking industry is about the rise in non-performing assets (NPAs). But the sector's gross NPAs-to-gross advances of 2.25 per cent compares well with the international norm of 3 per cent.