India's financial sector should brace for challenging times ahead with an increased risk of deterioration in asset quality and lower demand for loans, the Reserve Bank of India (RBI) said in a report on Tuesday.
The central bank has introduced various measures to support the banking sector including a relaxation in recognition and provisions for bad loans to protect lenders and creditors during the coronavirus pandemic.
The roll back of these measures could now hit the books of banks.
"The challenge is to rewind various relaxations in a timely manner, reining in loan impairment and adequate capital infusion
for a healthy banking sector," the central bank said it in its annual report on Trends and Progress of Banking in India.
Non-banking financial companies (NBFCs) or shadow banks may see a hit on their profitability going forward due to asset quality concerns, lower credit demand and the tendency to preserve cash, the report said.
Toxic loans on the books of Indian banks have eased with gross bad loan ratios falling to 7.5% at the end of September 2020 from 9.1% in March, but it said that going forward such loans could rise again following relaxations being lifted.
The six-month loan moratorium on repayments provided by central banks and the supreme court judgment prohibiting recognition of bad loans since September may have also provided some respite to the banks on asset quality.
Concerns still remain on non-performing assets, particularly on credit card loans which does not augur well for the risk-profile of Indian banks.
"Given the uncertainty induced by COVID-19 and its real economic impact, the asset quality of the banking system
may deteriorate sharply going forward," the RBI said.
The report also said Indian banks had written-off loans worth 2.38 trillion rupees ($32.46 billion) in the financial year 2020 that ended on March 31.
The overall outlook for the Indian economy in 2021 continues to remain uncertain, the report said.
"The high debt overhang of households, non-financial corporates and the (national and sub-national) governments remains a serious concern," the central bank said.