Indian banks have been hit by the protracted economic slowdown that stretched the liquidity of India Inc. The problem was further compounded by the policy paralysis of the previous government that put a brake on the capital investments in the country. As a result Indian banks, particularly public sector banks have piled up a large amount of bad loans. The gravity of the situation is reflected in the fact that the proportion of bad and restructured loans in the banking system in FY16 will reach the highest level since 2001 (Source: India Ratings and Research Pvt., Fitch unit). The steep rise in non-performing loans has led to higher provisioning thereby exerting pressure on the profitability of banks.
While reform measures by the present NDA government have led to a gradual recovery in the economy, the RBI governor has said that the improvement in the credit quality of banks will be slow. This is partly because companies are refraining from selling assets to reduce borrowings on expectations of higher valuations once the economy gains momentum (Source: Crisil). Even the growth in bank lending has languished in single-digits. The credit growth has been slow despite the RBI lowering the liquidity requirements for banks as well as cutting down interest rates twice in 2015. On a positive note, the cost of insuring credit defaults for banks has come down substantially on better recovery prospects.