Indian banks likely to face delay in asset-quality recovery owing to demonetization, says Fitch Ratings

Indian banks are expected to face difficulties in the recovery of the banks’ asset-quality, owing to negative impacts of demonetization that thronged the economy with a heavy cash crunch post its implementation from November 8, 2016 midnight onwards.

Cash shortages caused by the demonetization of large-denomination currency notes have affected the income of many borrowers - by holding back economic activity - and reduced their short-term repayment abilities, Fitch Ratings reported in its latest release.

The Reserve Bank of India (RBI) has allowed forbearance on some loans to the agricultural sector and small businesses but these account for a relatively small share of outstanding lending. The impact of demonetization on asset quality is likely to only start showing up significantly in data for the January-March quarter.

Demonetisation has also weighed on loan growth, at least in the short term. Loan demand has weakened in the uncertain economic environment and banks have had to focus on cash management instead of normal lending activities.

"We now think it is likely that loan growth will be below our previous forecast of 10 percent in FY17 and may even slow from the 8.8 percent recorded in FY16," the report commented.

However, it is still possible that demonetization will support loan growth over the longer term. Indian banks have received a surge of low-cost funding as demonetized notes have been deposited. Some banks have already responded by lowering lending rates, by up to 90 basis points as in State Bank of India's case, which could help revive credit demand, particularly if there are further cuts.

Meanwhile, excess capacity and the large number of stalled projects across much of the industrial sector will limit loan demand from capital-intensive businesses. Fitch estimates Indian banks will require around USD90 billion in new total capital by end-FY2019 to meet Basel III standards.