In a report titled 'Indian Banks: Improved Performance in Recent Years', Fitch said profitability was under pressure due to falling trading income in a rising interest rate environment.
"The proposed Basel-II guidelines will result in capital raising remaining a priority, and coupled with a growing need for scale, it may well trigger some sort of consolidation in the industry," the report said.
Finding that Indian banking system was fragmented with a median asset size of $5.0 billion and that most of the banks were relatively small by global standards, Fitch said, "Future mergers among healthy government banks are expected to create a few national champions, who would lead the system's ongoing migration to increased health."
With competition intensifying, it said banks have started recognising the importance of scale in operations to meet the growing needs of the corporate sector, product cost, risk management and product delivery systems.
Noting that the proportion of non-performing assets have been halved between 2001-02 and 2003-04, the report said asset quality concerns have receded through a combination of NPA write-offs, recovery efforts and improved credit appraisals.
Though the 're-structured' performing loans remain a weak link, Fitch expects the asset quality of Indian banks to remain generally stable or improve slightly as fresh NPAs have slowed down over the last 2-3 years, it said.
As trading incomes fall, banks have been trying to develop other non-interest income streams, including distribution of third party investment and insurance products and wealth management.
Pointing out that technology has emerged as a key differentiator, Fitch said PSU banks are trying to catch up with new private and foreign banks. The government banks are also retraining staff with particular focus on selling and marketing skills.
Indian banks, which attracted capital infusion from a buoyant market after their robust performances in recent years, are improving competitiveness and quality of earnings by investing in technology and risk management systems.
Though the improvement is noteworthy, "banks will need to continue to upgrade their credit appraisal and monitoring systems to handle the rapidly growing consumer loan business, besides managing their existing corporate and SME loans," it said.
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