Non-performing loans in the Indian banking sector is likely to witness an uptick and may shoot up to 11 per cent of gross loans in the next 12-18 months, S&P Global Ratings said on Tuesday.

It said forbearance is “masking” problem assets for Indian banks arising from COVID-19 and the financial institutions will likely have trouble maintaining momentum after the proportion of Non-performing loans (NPL) to total loans declined consistently so far this year.

“While financial institutions performed better than we expected in the second quarter, much of this is due to the six-month loan moratorium, as well as a Supreme Court ruling barring banks from classifying any borrower as a non performing asset,” S&P Global Ratings credit analyst Deepali Seth-Chhabria said.

In its report titled “The Stress Fractures In Indian Financial Institutions”, S&P said with loan repayment moratoriums having ended on August 31, 2020, NPLs in the banking sector will likely shoot up to 10-11 per cent of gross loans in the next 12-18 months, from 8 per cent on June 30, 2020.

According to S&P, the banking system’s credit costs will remain elevated at 2.2-2.9 per cent this year and next.

“Resumption of economic activity, government credit guarantees for small to mid-size enterprises, and buoyant liquidity is helping to limit stress. Our NPL estimates are lower than previous but we are still of the view that the sector’s financial strength will not materially recover until fiscal 2023 (ended March 31, 2023),” it said.

According to S&P, 3-8 per cent of loans could get restructured.

Banks and non-bank financial companies (NBFCs) have also been strengthening their balance sheets and bolstering their equity bases. Banks have also been building reserves and creating excess COVID provisions, which in our view should help them smooth the hit from COVID-related losses.

“For NBFCs we rate, performance has been improving. Like with banks, collections have surged for NBFCs. Top-tier NBFCs are benefiting from surplus system liquidity, as indicated by a sharp reduction in risk premiums. Weaker finance companies, however, have faced higher risk premiums. We expect such polarisation to persist in 2021,” S&P added.