'Banks showing positive signs but fundamentals still weak'

Singapore: Notwithstanding the positive signs in the Indian banking sector, fundamentals still remain a long way from returning to "healthy level", a DBS report said Friday.

According to the global financial services major, the recent second quarter earnings of Indian banks showed some positive signs with a slight improvement in asset quality.

Overall, most banks showed a reduction in gross non-performing loans (NPLs) and lower formation of new NPLs. Some banks also expect further improvement in asset quality in the coming quarters, noted the report.

Lower credit costs also helped the bottom line of the banks, as the countries two leading lenders -- State Bank of India and ICICI Bank -- returned to profit in the September quarter after reporting losses in the prior quarter.

"Gross NPL ratio of our sample remains above 10 per cent while capitalisation remains just about adequate (Tier I ratio of 9-10 per cent)," DBS said in a research note adding, the government is expected to maintain capital levels of banks through periodic equity injection.

The report further noted that asset quality issues are unlikely to be resolved without "exceptional measures", and hence will remain a long-term issue.

DBS however cautioned that the recent improvements seen could slow down as recoveries from ongoing bankruptcy resolutions get more challenging once the better quality assets are sold.

Valuations of Indian bank $bonds remain relatively expensive and do not offer much upside from current levels. Hence, the bonds have not reacted to the second quarter results unlike equities of the banks which have seen a rally.

"That said, bond valuations are driven by government ownership and supported by the strong technicals (absence of new bond supply). At best, Indian bank bonds are suitable for buy and hold investors for coupon carry, the report said.