RBI Signals Further Dilution Of Asset Classification Standards: Fitch

New Delhi, February 10: The Reserve Bank of India's (RBI) announcement on February 6 of forbearance towards stressed sectors signifies a gradual shift away from the regulator's earlier effort to enhance the quality and transparency of asset classification in Indian banking system, said Fitch Ratings.

There is a risk that such regulatory forbearance would perpetuate moral hazard, as it follows aggressive lending growth and risk-taking in certain sectors in the five years to the financial year ended March 2019 (FY19), it said.

Fitch analysed that the RBI's extension of the one-time restructuring scheme for micro, small and medium-sized enterprises (MSMEs) and the announced relaxation in asset classification for certain real-estate projects mark a further dilution of the regulator's drive to enhance loan recognition.

“It is not clear at the moment whether this forbearance will be extended to non-bank financial institutions (NBFIs) as well, but we believe that the probability of this is high, considering the impact that the NBFI liquidity squeeze and a slowing economy have had on the MSME and real-estate sectors. In recent years, banks have preferred to lend to NBFIs, which lend heavily to the real estate and MSME sectors, as a way to deploy their excess liquidity, while limiting their own direct exposure to these areas,” the report stated.

The report said it is unclear whether the latest announcement marks a substantial shift in the RBI's policy approach. Nevertheless, it is not surprising in the current weak operating environment and is in line with a recent trend to weaken asset recognition standards. This was among the factors that prompted us to lower our operating environment score for India's banking sector in 2019.

Fitch believes that these extensions are only likely to defer asset-quality pressures unless there is a sustained improvement in macroeconomic conditions.

“Although we expect India's economic growth to pick up in the coming months, to 5.6 per cent in FY21 from 4.6 per cent in FY20, there are still risks to the country's economic outlook,” it added.