Mounting repayment pressure for some borrowers, particularly micro, small and medium-sized enterprises, amid India's interest rate hikes will test banks' loan underwriting quality, Fitch Ratings said on Thursday.
However, asset-quality risks from higher rates should generally be moderate for most banks, it said in a statement.
Higher rates will also affect securities valuations and could make it harder for banks to raise fresh capital, particularly at state banks, although wider net interest margins (NIM) will have offsetting positive credit effects, it added.
The Reserve Bank of India (RBI) raised policy interest rates by 50 bps to 4.90 per cent in June.
"We expect rates to rise further, reaching 5.90 per cent by end-2022 and 6.15 per cent by end-2023, then remaining at this level through 2024," it said, adding banks have been quick to pass on higher rates through loan portfolios, which are mainly floating in nature but have been slower in raising deposit rates.
This trend should support higher NIM, but the lack of competition for deposits may point to relatively muted demand for new credit, it said.
"We expect banks' capital buffers to remain commensurate with current ratings in the near term, although weaker capitalisation will be a greater constraint on loan growth at state banks than at private-sector rivals.
"Higher interest rates could make raising additional private capital more challenging, making state banks more reliant on equity injections from the government if they are to maintain market share," it added.
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