The new framework's overall focus is on recognising and quickly resolving bad loans.
New Delhi: The Reserve Bank's new norms for overhauling the mechanism to deal with bad loans is aimed at speeding up the NPA resolution, but would undermine the banking sector earnings in the near-term, credit rating agency Fitch said on Thursday.
However, stronger regulatory efforts to clean-up bad loan problems, combined with planned recapitalisation of state banks, could help support a recovery in the sector over the medium term, the US-based agency said in a statement.
Regulators appear increasingly impatient with the slow resolution of NPL stock, which has prolonged the non-performing loan (NPL) cycle, it added.
"India's new framework aimed at speeding up NPL resolution is likely to push up banks' credit costs and undermine earnings in the near-term," said Fitch, which has a negative outlook on the banking sector.
The new framework gives banks less discretion over the reporting and resolution of bad assets and attempts to address the complexities involved in resolving the stressed loans of large borrowers.
"Banks will need to report defaults by large borrowers weekly, indicating a more invasive approach to tracking bad assets," it said.
The timeline for dealing with bad loans has also been made prescriptive, with banks and borrowers forced to implement a plan for resolving loans within 180 days of default or go to insolvency court.
"The new framework's overall focus is on recognising and quickly resolving bad loans. It is likely to result in a rise in NPLs, as banks are forced to reclassify stressed accounts previously recorded as special mention loans or restructured loans.
"More accounts are also likely to be pushed toward insolvency courts and into liquidation, particularly since the new guidelines require all of a borrower's lenders to agree on a resolution plan to keep it away from the courts," Fitch said.
Fitch said most of the USD 32 billion (Rs 2.11 lakh crore) of fresh capital the government plans to inject into state banks by end-March 2019 is likely to be absorbed by losses associated with NPL resolution. "Asset growth is therefore likely to remain low and earning will stay under pressure".
It further said that the USD 1.8 billion (Rs 11,400 crore) fraud in a Mumbai branch of Punjab National Bank (PNB) underlines the risks to bank performance posed by poor risk control and management supervision, which are a weakness across much of the sector, and have contributed to bad loan problems.
Fitch has placed PNB on 'Rating Watch Negative' with possibility of future downgrade.
In the new norms at dealing with NPAs, RBI last week specified rules for "early identification" of stressed assets, timelines for implementation of resolution plans, and a penalty on banks for failing to adhere to the prescribed timelines.
It has also withdrawn mechanisms like Corporate Debt Restructuring Scheme, Strategic Debt Restructuring Scheme (SDR), Scheme for Sustainable Structuring of Stressed Assets (S4A).