With deceleration in growth and tight liquidity conditions, the country's financial institution sector may continue to face challenging operating environment, according to a report by Fitch Ratings.
It said the stress in non-banking financial companies, small and medium enterprises (SMEs) and the real estate sector will continue to put asset-quality pressures on financial institutions in the country.
"The Indian financial institutions (FIs) sector will continue to face a difficult operating environment amid the macroeconomic slowdown and weak funding conditions," the rating agency said in a note on Wednesday.
The rating agency expects the real GDP growth to slow to 4.6 per cent in 2019-20 from 6.8 per cent in 2018-19, led by a squeeze in credit availability from non-banking financial institutions (NBFIs) and deterioration in business and consumer confidence.
However, the real GDP growth may rebound to 5.6 per cent in 2020-21, it said.
The report said asset-quality tensions are likely to intensify if stresses on non-banks, real estate and SMEs remain unresolved.
Idiosyncratic stress in the telecom sector has also pushed up asset-quality risks for banks, which are vulnerable due to weak capital and income buffers, it said.
"The potential for contagion for banks, thus, exists as a result of their direct exposure to NBFIs as well as the second-order economic impact of being exposed to the sectors that are adjusting to the credit squeeze as the NBFIs cut back exposure," the rating agency said.
The banking system's average impaired loans ratio had fallen to 9.3 per cent by 2018-19 from 11.6 per cent at 2017-18, the first decline since 2020-11.
According to the latest Financial Stability Report released by the RBI, the gross non-performing loans of banks may increase to 9.9 per cent by September 2020 from 9.3 per cent in March 2019.
The rating agency said the recent fundraising trends by a few NBFCs in January and February 2020 indicate improvement in funding environment.
The rating agency expects NBFIs to continue to tap the offshore market, but access is likely to remain uneven and limited largely to retail-focused NBFIs and those backed by large corporate groups. Wholesale and housing finance companies are the most at risk as they will continue to find it difficult to raise funds, given their greater exposure to the real-estate sector where there is pressure on cash flows and collateral values.