NPLs will likely rise to 10-11% in of gross loans in the next 12-18 months.

Forbearance is masking problem assets for Indian banks arising from the pandemic as the sector and other financial institutions will have a hard time keeping momentum after the ratio of NPLs to total loans have been dropping so far, a S&P Global Ratings report said.

The performance of financial institutions in the second quarter was mostly brought about by the six-month loan moratorium period as well as a Supreme Court ruling that prevented lenders from classifying any borrowers as a nonperforming asset, noted analyst Deepali Seth-Chhabria. But with repayment moratoriums having ended on 31 August, NPLs will likely rise to 10-11% of gross loans in the next 12-18 months.

Hence, system credit costs will remain high at 2.2-2.9% this year and in 2021, in line with forecasts of elevated credit cost for many other countries in Asia Pacific. Stress will also be limited by the resumption of economic activity, government credit guarantees and buoyant liquidity.

“Our NPL estimates are lower than previous but we are still of the view that the sector's financial strength will not materially recover until fiscal 2023\. By our projections, 3-8% of loans could get restructured. At this juncture, we believe that the system restructuring could be at lower end of our estimates,” the report noted.

Collection rates, which improved sharply in Q2 to an average 95%, may also wane due to the pickup in economic activity and by the savings of the borrowers. However, savings could deplete fast, potentially hurting future collections.

Banks and nonbank financial companies (NBFCs) have also been strengthening their balance sheets and bolstering their equity bases. Banks have also been building reserves and creating excess COVID provisions, which should help them smooth the hit from COVID-related losses.