Mumbai: Fitch has downgraded the credit ratings of two private sector lenders— ICICI Bank and Axis Bank—to junk at a time when the banking sector is struggling with poor asset quality and weak core capitalization.

Reacting to the development, ICICI Bank lost 1.6% in intraday trading on Tuesday, ending the day lower by 0.92% at ₹418.95 on the BSE. Axis Bank, on the other hand, lost 0.8% on an intraday basis but ended the day gaining 1.12% to close at ₹821.40. The benchmark Sensex lost 0.46% to close at 40,083.54 points.

Fitch downgraded the long-term issuer default rating (IDR) to BB+ from BBB- for both banks. These downgrades follow Fitch lowering its midpoint for India’s operating environment to BB+ from BBB- after a review of the banking sector’s performance in the last three years, its regulatory framework, and the outlook in the near term.

An analyst who declined to be named said the rating downgrades, which cited a difficult operating environment in India, are strange because other banks operating in the same environment have not been downgraded.

Fitch said it “compared the operating environment in India, using key metrics such as gross domestic product per capita and the ease-of-doing-business ranking, with those of other sovereigns in Asia rated in the BBB category".

The rating agency expects the performance of India’s banking sector to be below average over the next one to two years despite faster growth and improved business prospects. Banks in India can take advantage of this only if their damaged balance sheets recover sustainably with the infusion of fresh equity that encourage them to support credit growth, said Fitch.

The one-notch downgrade of ICICI Bank, Fitch said, reflects its assessment of India’s operating environment and its belief that several of ICICI Bank’s key financial indicators are generally weaker than those of banks rated higher by Fitch. It said the downgrade of Axis Bank’s viability rating reflects its relatively weak core capitalization and asset quality, which, despite some improvements in the near term, are not commensurate with Fitch’s expectations of higher rated entities.

Fitch believes the performance of Indian banks has largely bottomed out, but the sector is still struggling with poor asset quality and weak core capitalization. It said Indian banks’ impaired loan ratio fell to 10.8% at end-December 2018 from 11.5% on 31 March 2018, which continues to be high by global standards.

“Capital buffers are still assessed by Fitch as moderate, including for private-sector banks, especially in light of their high impaired loan ratios, high risk appetite and the challenging but competitive operating environment," it said.

Bad debts seem to have eased for public sector banks and also somewhat for private lenders in FY19. Mint reported on 4 June that aggregate bad loans of state-run banks declined 12% to ₹7.17 trillion in the year ended 31 March.

For private sector banks, the reduction in gross bad loans was 1.3% during the same period.

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