Fitch Affirms ICICI Bank at 'BB+'; Outlook Negative

Fitch Ratings - Singapore/Mumbai - 29 Nov 2021: Fitch Ratings has affirmed ICICI Bank Limited's (ICICI) Long-Term Issuer Default Rating (IDR) at 'BB+'. The Outlook is Negative. The agency has also affirmed the bank's Viability Rating (VR) at 'bb'. In line with the updated Bank Rating Criteria, we have assigned ICICI a Government Support Rating (GSR) of 'bb+'. A full list of rating actions is below.

The operating environment (OE) outlook of Indian banks was recently revised to stable from negative, reflecting a better recovery than we expected in business and economic activity following the COVID-19 pandemic's second wave. The 'bb' OE score is higher than the implied score of 'b', reflecting our view that India's economy will generate sustainable business growth opportunities. Economic momentum and regulatory measures should support modest improvements in Indian banks' financial profiles over the next 12-24 months, even though challenges remain.

Fitch is withdrawing ICICI's Support Rating and Support Rating Floor as they are no longer relevant to the agency's coverage following the publication of our updated Bank Rating Criteria on 12 November 2021.

Key Rating Factors

Idr And Government Support Rating

ICICI's Long-Term IDR of 'BB+' is support driven and linked to India's sovereign rating (BBB-/Negative). It is driven by its GSR of 'bb+', which is higher than the VR. The GSR is one notch below the sovereign, reflecting Fitch's expectation there is a moderate likelihood of extraordinary state support to ICICI if required. This is due to its size and systemic importance, which stem from its large and growing market share (6.1% of system assets and 5.5% of deposits in the financial year ended March 2020 (FY20)) and a sizeable retail deposit franchise. However, we regard the likelihood of support for ICICI to be lower than for large state banks that have GSRs of 'bbb-' due to ICICI's private ownership but to be similar to that of other large private banks.

Nevertheless, ICICI is a systemically important bank and the state has a record of supporting such banks, although ICICI has not required support to date. The March 2020 rescue of Yes Bank Ltd., a mid-sized private-sector bank, reinforces our view.

The long-term IDR outlook is negative, mirroring the outlook for the Indian sovereign IDR.

Senior Debt

ICICI's senior debt rating is at the same level as the Long-Term IDR, as the debt represents the bank's unsecured and unsubordinated obligations.

Viability Rating

ICICI's VR is one notch below Fitch's implied VR of 'bb+' due to its risk profile, which serves as a negative adjustment. In Fitch's view, the bank's risk profile has a stronger impact than the OE on the assigned VR than what the weighting would suggest. The bank's appetite for risk, even though it is lower than before the pandemic, has weighed on its financial metrics in the past several years, particularly in terms of asset quality and earnings. The VR incorporates some risk of deterioration in financial metrics (not our base case over the next two years) - particularly asset quality beyond FY23, although we expect ICICI's loss-absorption buffers to reasonably withstand moderate shocks.

The VR also factors in ICICI's business profile, which is scored at 'bbb-'. It reflects Fitch's view that ICICI's wide reach, diversified business model and well-capitalised balance sheet should enable the bank to further expand its strong domestic franchise, supporting profitable business and market-share gains through the cycle.

ICICI's capitalisation and leverage factor score are unchanged at "BB+" with a stable outlook. It reflects Fitch's expectation that the bank's common equity Tier 1 (CET1) ratio would remain well above 12% in the next two years, supported by improving internal accruals.

ICICI's CET1 ratio of 16.2% is comparable with that of large private banks, with a buffer of nearly 800bp over the regulatory minimum of 8.2% applicable to ICICI, which is a designated domestic systemically important bank. The bank has good flexibility in accessing equity capital markets as well as good capital fungibility through its well-established profitable subsidiaries. Fresh equity and improving loan-loss cover (1HFY22: 80%) have also eased capital risks with the net impaired loan/CET1 ratio dropping to 6.1% in 1HFY22, from 30.5% in FY18.

The full extent of ICICI's exposure to special-mention loans and the non-guaranteed portion of emergency loans is less clear, but we do not expect capital buffers to fall below 12% under our base scenario, provided risks from the vulnerable loan pool manifest as per Fitch's expectations.

The bank's asset-quality factor score benefits from good diversification of credit exposures, including its more granular retail portfolio. The score is maintained at "bb-" with a negative outlook due to Fitch's view that the four-year average impaired-loan ratio could face pressure and may not be sustained below Fitch's "bb" threshold of 5% once regulatory forbearance wears off, even though we expect the core metric to improve in the near term, supported by a stable OE and relief measures. It reflects our belief that the bank's risk profile will have a stronger influence on its asset quality over the medium-to-longer term.

The impaired-loan ratio declined by 10bp to 5.2% in 1HFY22 from FY21, accompanied by a drop in loan impairment charges/gross loans to 1.4% in 1HFY22, its lowest in many years. It is still some distance away from the sub-1% levels before FY16 but we expect loan impairment charges/gross loans to further improve in the near term, supported by a declining impaired-loan ratio as the reduction in bad loans (1HFY22: 0.8% of loans) continues to outpace additions (0.6%). Asset quality and credit costs could face renewed pressure after FY23 when regulatory relief unwinds meaningfully.

ICICI's earnings and profitability factor score is maintained at 'bb' with a stable outlook to reflect Fitch's expectations that the four-year average operating profit/risk-weighted asset (OP/RWA) ratio will achieve Fitch's 'bb' threshold of 1.25% by FY22 and be sustained above that level. ICICI's OP/RWA improved to 3.2% in 1HFY22 from 2.1% in FY21. We do not see significant risks to earnings in the next one to two years but believe loan impairment costs will remain instrumental in driving OP/RWA, particularly as and when the forbearance unwinds.

Like other large banks in India, ICICI's deposit franchise has proven resilient through difficult operating conditions, including the failure of Yes Bank in 2020. ICICI's stable funding and liquidity profile benefit from its retail-oriented and local currency-dominated deposit franchise with a wide reach. The bank's gross loan/customer deposit ratio of 82% has been falling since FY15 but that could change in the near term with more momentum around loan growth. The bank's low-cost deposit ratio of 46% in 1HFY22 is comfortably placed relative to peers while its stable liquidity position is reflected in its liquidity-coverage ratio of 129% as of 1HFY22. We expect both variables to somewhat normalise over the medium term.

Rating Sensitivities

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Senior Debt and Government Support Rating

We would downgrade the GSR, and, in turn, the bank's IDR if we believe that the sovereign's ability to support the bank has weakened, which could be the case if the sovereign rating were to be downgraded. The IDR could also come under pressure if we believe the state's propensity to support the bank has weakened, even if India's sovereign rating remains unchanged, although this is not our base case. There is limited downside risk to the IDR in the event of a VR downgrade, so long as the GSR remains unchanged, which would imply that our assessment of the sovereign's ability and propensity to support the bank remains intact.

The senior debt ratings would be downgraded if ICICI's Long-Term IDR is downgraded.

Viability Rating

ICICI's VR represents a moderate degree of financial strength. It should be reasonably stable in the near term but could be downgraded if the significant deterioration in the OE, or a heightened risk profile, were to become a more binding constraint on the bank's loss-absorption buffers.

This could manifest through a combination of weaker key financial metrics, assuming our assessment of its business profile remains unchanged:

- a drop in ICICI's CET1 ratio to well below 12%, irrespective of its better capital flexibility, without a credible plan to restore it to closer to 12%; alongside

- a reversal in the asset-quality trend with the four-year average impaired-loan ratio approaching 10%; and

- four-year average OP/RWA ratio sustained below 1.25%.

A lower business profile score for ICICI - though not our base case - could also lead to a VR downgrade if it is also accompanied by the above-mentioned financial metrics being hit.

Factors that could, individually or collectively, lead to positive rating action or upgrade:

Senior Debt and Government Support Rating

A revision of the sovereign rating Outlook to Stable would lead to a corresponding revision on the Outlook on ICICI's Long-Term IDR, provided the sovereign's propensity to support remains unchanged.

An upgrade to ICICI's GSR is possible in the event of a sovereign upgrade if it coincides with a strengthening of the sovereign's ability and, more importantly, propensity to support the bank. However, an upgrade of the sovereign rating appears less likely in the near term, considering the Negative Outlook.

An improvement in ICICI's VR beyond its GSR would also lead to its IDR being aligned with the VR. However, such an upgrade is not envisaged in the near term and will likely coincide with a higher OE score.

Viability Rating

ICICI's VR is regarded as constrained by its risk profile, with a challenging OE also being a factor. However, an upgrade is possible in the case of a higher OE if it is coupled with sustained improvements in ICICI's key core metrics, which could point to a more moderating risk profile. The financial improvements could manifest through a combination of stronger key financial metrics, such as:

The four-year average impaired-loan ratio was sustained well below 5%, alongside

four-year OP/RWA ratio well exceeding 3%; and

CET1 ratio sustained at or above current levels.

VR Adjustments

The OE score of 'bb' has been assigned above the implied category of 'b' for the following adjustment reasons: economic performance, and size and structure of the economy (positive).

The asset quality score of "bb-" has been assigned above the implied category of "b" for the following adjustment reason: concentrations (positive).

The funding and liquidity score of "bbb-" has been assigned above the implied category of "bb" for the following adjustment reason: deposit structure (positive).

Best/Worst Case Rating Scenario

International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories range from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance.

Substantially material sources are cited as the key drivers of the rating.

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

ICICI has an ESG Relevance Score of '4' for Financial Transparency. It reflects our assessment of the quality and frequency of financial reporting and the auditing process, which has a moderate but negative influence on the credit profile and is relevant to the rating in conjunction with other factors.

Occurrences of material asset-quality divergence have been minimal in recent years while the bank has also managed to successfully isolate itself from whistle-blower allegations in 2018. Nonetheless, government and regulatory pandemic-related relief measures pose a risk to transparent recognition of impaired loans, even though we expect ICICI to be reasonably placed among peers. Still, financial transparency is considered pivotal for general business and depositor confidence and can lead to significant reputational risk if not managed well.

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or how they are being managed by the entity.