Bad loans to rise at Indian banks as easy liquidity may tighten: Fitch

Bad loans and credit costs are expected to rise at Indian banks as easy money policies to shore up a pandemic-battered economy may start to tighten, Fitch Ratings said on Monday.

The coronavirus lockdowns last year slammed an already struggling financial sector, but recent quarterly reports have shown an improvement in profits and asset quality.

Noting that the recent improvement masked underlying pandemic stress, Fitch said banks would increasingly feel the pinch from the continued impact on small businesses and rising unemployment.

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"Fitch believes that the disproportionate shock to India's informal economy and small businesses, coupled with high unemployment and declining private consumption, have yet to fully manifest on bank balance sheets," the rating agency said in a note.

India's economy returned to growth in the third quarter, but many sectors continue to operate below capacity and some indicators point to stress in retail customers, Fitch said.

Fitch added it sees high risk of a "protracted deterioration" in asset quality with more pressure on loans to retail and stressed small and medium-sized enterprises.

The Reserve Bank of India had in January warned that banks may see bad loans double to 14.8% under a severe stress scenario.

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State-owned banks, with their limited capital buffers, will be more vulnerable to the impact of the pandemic than private-sector peers, and the government's plan to pump $5.5 billion into these lenders over fiscal 2021 and 2022 is unlikely to be enough, Fitch said.

The ratings agency estimates state-owned lenders need $15-58 billion in capital, under various stress scenarios.

Higher contingency reserves at private banks, which offer them better earnings and capital resilience, make them better poised for growth in 2021, Fitch said.