Mumbai, Mar 8 (IANS): The impact of the Covid-19 pandemic is likely to pose challenges to the Indian banks' improving financial performance once asset-quality risks manifest in the financial year ending March 2022 (FY22), says Fitch Ratings.

According to Fitch, India's banks reported lower impaired loans and improved profitability for the nine months ended December 2020 due to various forbearance measures and continued large write-offs.

In a statement, Fitch said that India's banks - particularly state banks - remained more risk averse than in prior years, which was reflected in their weak credit growth.

"Fitch expects a moderately worse sector outlook for Indian banks for 2021-2022 based on muted expectations for new business and revenue generation, and deteriorating asset quality," Fitch said in a statement.

"The state's less-than-adequate recapitalisation plans for its banks further underscores the risk, which will likely keep risk aversion high among banks amid continuing uncertainty about asset quality and an uneven economic recovery."

According to Fitch, the disproportionate shock to India's informal economy and small businesses, coupled with high unemployment and declining private consumption, have yet to fully manifest on bank balance sheets.

"Indian banks' impaired-loans ratio declined by 130bp to 7.2 per cent at 9MFY21, but it is yet to factor in the majority of the pandemic stress, which is unrecognised due to judicial intervention or forbearance."

As these measures unwind, Fitch expects India's banks to reverse the improvements in asset quality and profitability, with state banks more vulnerable to higher stress than private banks, which have better profitability and higher contingent reserves and capitalisation.