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Mumbai: The final bastion in India’s $1.6 trillion banking sector faces a test of its resilience as private lenders brace for an erosion in loan growth and quality due to the coronavirus.

The nation’s strongest private banks — HDFC Bank Ltd., Kotak Mahindra Bank Ltd. and ICICI Bank Ltd. — had skirted the shockwaves that struck the state-owned banks and the shadow lenders in recent years, and which have left those sectors struggling under mountains of bad debt.

But after doling out nearly two-thirds of new lending in 2019, the private banks have been unable to escape the effects of India’s lockdown of its economy, which is expected to devastate many of their retail and corporate customers. If they now respond by curtailing new loans even to healthy borrowers, that will have serious consequences for the Indian economy and the pace at which it can emerge from the crisis.

“We expect a sharp slowdown in credit growth and deterioration of asset quality across all private banks,” said Saswata Guha, the head of financial institutions at Fitch Ratings in India. The individual impact “will depend upon their relative exposure to vulnerable small businesses and the risky unsecured retail segment,” Guha added.

India’s financial sector has been reeling from a shadow-banking crisis that swelled bad loans and culminated in the biggest bailout of a bank in the nation’s history. The coronavirus struck just as lenders were about to see signs of stability, forcing the Reserve Bank of India to further ease liquidity and bad-loan rules to keep funds flowing through the economy.

India’s lockdown — extended this week until May 3 — has left businesses struggling to stay afloat, with unemployment spiking to 23% in the last week of March and growth poised to shrink about 5% in the current quarter, the first contraction in at least two decades.

Total non-performing loans in the financial system may rise by 7 percentage points if India ends its lockdown by mid-May, according to a recent study by McKinsey & Co. At 9.3%, India already has the worst soured asset ratio of any major nation.

More than 25% of ICICI’s loan book is to sectors most vulnerable to the lockdown, such as small businesses and automobile finance, according to a March 30 report by Credit Suisse Group AG analysts led by Ashish Gupta. At Axis Bank Ltd. the proportion is 35%, the report said, while for smaller private lender IndusInd Bank Ltd. the ratio is as high as 45%.

For IndusInd, RBL Bank Ltd. and other smaller private lenders, the coronavirus crisis has also left them struggling to hang on to deposits, as funds migrate to the perceived safety of state-owned lenders. Those private-sector banks were already under pressure after the regulator barred deposit withdrawals from Yes Bank Ltd. as part of the bailout announced last month.

“Private banks’ ability to withstand deposit shocks will be key for their survival going ahead, given that a strong liability franchise is crucial for stability of a bank,” said Karthik Srinivasan, group head of financial sector rating at ICRA Ltd., the local arm of Moody’s Investors Service.

Tight funding conditions at shadow lenders and smaller private banks could force them to reduce lending, Moody’s warned in a report this week. “As a result, companies relying on either type of lender for funding, many of which have weak financials, will have difficulty in maintaining liquidity, which can result in defaults on loans,” Moody’s said.

The benchmark index of India’s private-sector banks has fallen just over 34% since the beginning of March, slightly more than the drop in the equivalent state bank index. That’s a reversal from last year, when the private banks rose 16% and public banks lost 18%.

Much of the historical share price outperformance of the private banks was based on their rapid loan growth when compared with their state sector peers, which have avoided taking on new lending due to a legacy of bad debt. But that gap is narrowing as even the largest private banks draw in their horns during the coronavirus crisis.

Kotak Mahindra Bank’s loan growth dropped to 6.7% in the first quarter of the year, the slowest in at least three years and down from 10.3% in the previous three months. HDFC Bank, with the lowest bad-debt ratio among its peers, has also become more stringent about taking on new lending, its managing director Aditya Puri said last month.

Some private-sector banks are big lenders to retail customers in India, a sector largely shunned until recently by the state banks, which have focused on large corporate borrowers. That specialty could now haunt the private lenders.

As well as auto loans, the Credit Suisse report said property, credit card and unsecured lending is especially vulnerable during the coronavirus crisis.

The scale of the challenge for private-sector banks should become clearer after Saturday, when HDFC Bank kicks off the latest earnings season by reporting results for the quarter ended March 31.

The RBI has given all banks a three-month grace period during which they have some relief from rules governing bad loan recognition. But from September onward, bad-loan rates are likely to surge if the crisis is still acute.

Private banks’ credit books grew at an annual 13% as of December, more than three times the pace of state banks, according to RBI data. If asset quality starts to deteriorate, their bad-loan ratios could rise from the 3.9% recorded in September, which was well below the 12.7% for state lenders.

“The longer Covid-19 lingers, we will face rising human costs, more businesses will struggle, more livelihoods lost and bad loans will rise further,” said Ananth Narayan, a professor and financial sector expert who was recently appointed an additional director at Yes Bank following its rescue. “Even after the lockdown ends, the economy will take a long time to revert to any normalcy.” –Bloomberg

Also read: Modi must not extend lockdown. Economy won’t survive on ventilator for long

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