Domestic banks well-positioned to cope with tapering: Moody's

The country's banking system is well-positioned to cope with the financial impact of the reduction in monetary stimulus by the US Federal Reserve and the resultant rise in interest rates, according to global rating agency Moody's Investors Service.

"The strengths of the banking systems in India and also in the Asean region are currently underpinned by their relatively strong capital buffers, modest levels of problem loans, high recurrent profitability and low reliance on foreign funding," Moody's vice-president and senior credit officer Eugene Tarzimanov said in a note.

The US Fed had on May 24 hinted at withdrawing its third round of quantitative easing, or bond buying programme, worth $85 billion each month, which began in the wake of the worst credit crisis in September 2008.

However, the Fed started trimming its programme in January.

The Moody's report, titled 'Asean and Indian Banks Resilient to US Tapering and Higher Interest Rates,' noted that compared with other emerging markets, Asean and Indian banks are more resilient to the potential adverse impacts associated with tapering, mostly due to the high economic growth rates in the region, relatively large reserves at the sovereign level, rising income levels and their own good credit fundamentals.

The report painted a good picture of Asean banks and said they will continue to benefit from a supportive economic environment in the region, characterised by growing trade flows between Asia and the recovering

US and European economies.

At the same time, the report warned that banks will see higher stressed loans on their corporate and retail books, especially on foreign currency loans, if their domestic currencies fall substantially.

That apart, negative financial market adjustments would also lead to mark-to-market losses on their bond investments.

However, the report stated that higher interest rates will support banks' net interest margins, which, to some extent, will mitigate their higher credit costs.

The Moody's report said banks may face pockets of risks as tapering lifts their economies from a long period of low interest rates and speculative capital inflows into a new credit cycle characterised by slower economic and credit growth and higher cost of funds.

Tarzimanov, in particular, warned that the key downside risks are a sharp rise in debt-servicing burdens in economies that have seen strong credit growth and are now more leveraged, and adverse asset price adjustments that may affect their capitalisation position and loan quality.

For example, the Asean and Indian economies have seen pronounced gains in real estate prices in recent years.

The report sees interest rates likely rising in the US and the rest of the Western economies and capital flows reversing due to the tapering.

In addition, funding will not be a key risk because these banks exhibit low levels of forex borrowings.

Most operate with loan-to-deposit ratios of about 90 per cent, with foreign currency borrowings accounting for less than 2 per cent of liabilities.