Christmas cheer for Indian banks, but Santa isn’t taking away the bad loans

After waddling in the toxic loan mess for several quarters, there is finally some Christmas cheer for India's banking sector.

The worst may be over for banks, the Reserve Bank of India (RBI) said in its bi-annual Financial Stability Report (FSR) released on Dec. 21. "India’s financial system remains stable. The stress in the banking sector, particularly the PSBs (public sector banks), while significant, appear to be bottoming out," the FSR noted.

However, it is too early for full-blown celebrations, the central bank warned. For bad loans are still rising: Gross non-performing assets (NPAs) increased to 10.2% in September 2017, compared to 9.6% in March. In the worst-case scenario, the RBI cautioned, this could go up to 10.8% by March 2018.

The banking regulator's report pulled up the PSBs, which account for the lion’s share of the bad loan mess. They financed a range of projects that lacked the potential, ultimately landing the lenders in a tight spot, it said.

Private banks, which have a relatively lower share of bad loans, registered a higher uptick in NPAs, the FSR noted. As of September 2017, private banks saw a 41% increase in gross NPAs in the last year, way higher than the 17% of the PSBs. This is partly because, despite the RBI cracking the whip on lenders in 2015, prodding them to recognise their share of bad loans, private banks have come to acknowledged the situation only in the last two financial years.

Meanwhile, the FSR states, as asset quality of companies in the textiles, rubber, cement, basic metals, and vehicles sectors improved between March and September 2017, that of firms in sectors such as mining, food processing, engineering, construction, and infrastructure worsened.

The International Monetary Fund has also warned about the high share of toxic loans that is making India's banks vulnerable.

"The financial sector is facing considerable challenges, and economic growth has recently slowed down. High non-performing assets and slow deleveraging and repair of corporate balance sheets are testing the resilience of the banking system, and holding back investment and growth," the IMF said in a report released on Dec. 21.

Clearly, it will be a while before Indian banks are out of the woods.