New Delhi, Aug 11 (PTI) The Reserve Bank's scheme to allow lenders to recast loans will extend uncertainty over the banking sector's asset quality, Fitch Ratings said on Tuesday.

In a major relief to corporate and retail borrowers, last week RBI permitted banks to go for one-time restructuring of loans that are facing stress due to the COVID-19 crisis with a view to mitigating risks to financial stability.

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According to Fitch, the scheme could open a window for banks to build capital buffers while putting off full recognition of COVID-19 pandemic's impact on loan portfolios, but is reminiscent of a strategy adopted over 2010-2016 that delayed and exacerbated problems for banks.

“The RBI's recent proposal to allow banks to restructure many types of loans will extend uncertainty over the banking sector's asset quality,” Fitch said.

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The scheme, which is applicable till March 2021, allows rescheduling of most retail and corporate loans, including MSME loans that were not impaired prior to March 1, 2020.

Rescheduling may take a number of forms, including moratoriums and extensions of loan tenors of up to two years, Fitch said adding that rescheduled loans are permitted to be classed as “standard assets”, even if they became impaired between March 1 and the implementation of the scheme.

Fitch noted that India's 2010-2016 experience with permitting broad-based debt restructuring was characterised by poor implementation and weak monitoring.

The central bank has tried to address this concern by tightening supervision, for example by setting up an expert committee which will vet all restructuring plans involving creditors with more than Rs 1,500 crore (USD200 million) of debt.

However, this does not address the issue of oversight for most retail and MSME lending restructured under the programme.

“In Fitch's view, these categories will account for a substantial portion of the future asset-quality stress linked to the pandemic. There is also a risk that the restructuring policy could undermine the insolvency and bankruptcy code, established in 2016, by side-lining the legal process that it set up,” it added.

Fitch believes that the restructuring scheme may be designed to give banks more time to raise capital to address the impact of the crisis on loan portfolios, the rating agency said in a statement.

Fitch had recently said that a number of Indian banks - both state-owned and private - have announced capital-raising plans, but that for state banks these moves were likely to be insufficient to mitigate anticipated risks without further capital support from the state.

“Raising capital remains challenging in the current environment. However, the new policy will reduce transparency over asset quality, which could further hinder some paths for capital-raising,” Fitch said.

Private investors, for example, may be more reluctant to participate in sale of stake in state-owned lenders until the impact of the pandemic on their balance sheets is clear, it added.

Delaying recognition of problems in the banking sector could provide some short-term support to economic growth by stimulating credit issuance, Fitch said.

The RBI has also raised the loan-to-value cap on credit issued against gold from 75 per cent to 90 per cent, in its efforts to boost lending.

“However, many state banks may remain reluctant to lend to all but the most creditworthy borrowers in the near term, as their overall weak capital position remains unsupportive of growth - even with impaired loans permitted to be classified as “standard” after rescheduling,” Fitch added.

The Issuer Default Ratings (IDRs) of Fitch's rated Indian banks are all support-driven, based on India's sovereign rating, so are unlikely to be directly affected by the RBI's scheme.

“However, banks' standalone Viability Ratings may face downward risk where we do not regard capital buffers as commensurate with heightened balance-sheet risks.

“In the past, when restructuring impaired loans and classifying them as “standard” was common, we assessed banks' asset quality and capital on an adjusted basis, and we would be likely to adopt this approach if banks restructure a substantial portion of their loan portfolios under the new proposals,” Fitch added.

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