Smaller Private Banks Expected to be Severely Hit by Covid-19, Warns Moody's Moody's has downgraded outlook for Indian banking system to negative from stable in view of Covid-19 economic impact

Moody's Investors Service revised the outlook for Indian banking system to negative from stable. The credit rating agency cited damage to economic activity led by coronavirus or Covid-19 outbreak as the reason for the downgrade, adding that the disruption has worsened the ongoing slowdown in the country's economic growth.

The negative outlook indicates that the growing scope of economic and market disruption from the coronavirus outbreak will increasingly strain bank's operating environment and loan performance, it explained.

Moody's has changed its outlook on 12 Asia Pacific banking systems, including Australia, China, New Zealand and Singapore, among others, to negative in light of the coronavirus crisis and broader economic deterioration.

In India, deteriorating global economic conditions coupled with the 21-day countrywide lockdown imposed by the government to check the spread of the virus will weigh on domestic demand and private investment, Moody's said. Moreover, heightened risk aversion among banks and debt market participants following a default by Yes Bank will hamper credit supply to the economy.

How will Banks Suffer

Credit flow in the economy was already restricted by liquidity constraints in the banking and non-banking financial sectors even prior to the coronavirus outbreak. Now, volatility in global financial markets in the wake of coronavirus crisis coupled with growing risk aversion in the banking system will further hamper credit supply. In fact, heightened risk aversion in the system will put liquidity pressure on small private sector lenders, curtailing even their capacity to lend.

As per Moody's, these factors along with widespread business disruptions will lead to a sharp decline in the economic growth of the country, which has already been slashed by the rating agency from 5.3 per cent to 2.5 per cent for 2020.

Also Read: Moody's Cuts India Growth Forecast in View of Covid-19 Shock

A sharp decline in economic activity and spike in unemployment will translate into decline of household and corporate finances, which in turn will result in an increase in delinquencies, said Moody's. Also, as the solvency stress among non-banking lenders increases, risks to bank's asset quality will dampen as they have large exposures to the sector, the agency statement added.

Smaller Private Banks and NBFCs to be Worst Hit

Moody's estimates that funding and liquidity at public sector banks (PSBs) will be stable because of strong public trust in them, thanks to sovereign backing. Moreover, support from the government for PSBs in the form of capital infusion will remain strong, which will contain the risk of any contagion of their balance sheet weakness to the system.

As for large private sector banks, they are also expected to have stable liquidity, given their well established franchises and strong depositor base. But, in the case of a failing bank, the government will not provide support, until it defaults, as can be seen in the case Yes Bank fiasco. However, authorities will step in to minimize losses to depositors and senior creditors after the failure.

Smaller private sector banks, with weaker franchises, will be the worst hit going forward. Default of Yes Bank will lead to risk aversion among depositors and creditors, creating funding and liquidity challenges for them.

Fitch Ratings has projected substantial impact on non-banking finance companies (NBFCs) due to business disruptions caused by Covid-19 crisis. NBFC's typically lend to micro and small businesses which have limited cash buffers. Any fall in their earnings is likely to affect their ability to repay loans directly, which will in turn exert pressure on their lender's operating performance and financial profiles, Fitch said.

"Government imposed restrictions in India will raise operational complications for the NBFCs, while any escalation in local infections would deal a blow to economic sentiment," said the rating agency's statement.

Fitch also slashed India's growth forecast for 2020 to a 30-year low of 2 per cent from the earlier 5.1 per cent.

Last week, the Reserve Bank of India (RBI) had announced a slew of monetary and regulatory measures to boost liquidity in the banking system in wake of economic impact of Covid-19. The central bank slashed the cash reserve ratio (CRR) to 58-year low of 3 per cent and dedicated INR 1 lakh crore to targeted long term repo operations (TLTRO) of three year tenure.

Also Read: RBI puts off EMIs, Slashes Interest Rates to Contain Impact of Covid-19 Lockdown