Profitability prospects of banks not bright: Report

New Delhi: Profitability prospects of the banking sector do not look bright owing to decline in lending rates and weak assets quality, BMI Research said Wednesday.

The banking sector continues to face multiple headwinds, the Fitch group company said in a statement, adding that it holds a negative outlook for the sector's fundamentals over the coming year.

"Net interest margins at Indian banks are likely to face downside pressure as the Reserve Bank looks to push the country's financial institutions to lower their lending rates further," it said.

The banking sector's profitability prospects do not look bright owing to a decline in lending rates and weak asset quality, BMI Research said, adding that private sector banks would outperform their state-owned counterparts due to better management, stronger capitalisation and higher earnings.

Banks continue to be plagued by bad debt and asset quality is unlikely to improve considerably anytime soon, it said.

This has resulted in weak credit growth to the commercial sector, BMI Research added.

The balance sheets of Indian companies remain stressed, it said, adding that it expects banks to continue to report a significant amount of bad debt.

"We expect loan growth to the commercial sector to remain tepid, and it is unlikely to pick up meaningfully over the coming months, as banks are likely to take a conservative approach to lending," it said.

It said the net interest margins of banks are likely to compress in the current fiscal as lending rates continue to decline.

The RBI is looking at introducing a new methodology for the calculation of the base rate so that lending rates would be more sensitive to changes in the central bank's policy rate.

"This move is likely to spur banks to cut their lending rates even more over the coming months," it said.

In an attempt to spur credit growth and support economic activity, the RBI slashed its key lending rate by 0.50 percent to 6.75 percent at its September monetary policy meeting. The RBI has lowered policy rates by 1.25 percent so far in 2015.

BMI Research said that banks have been lowering their deposit rates since September 2014, and it expects declines in lending rates to follow due to the reduction in repo rate and ample liquidity within the banking system.