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Credit rating agency Fitch Ratings on Tuesday said the pace of asset quality and profitability of Indian banks has exceeded its expectations.

Fitch also said a sustained improvement in the financial performance of Indian banks bodes well for the sector's intrinsic risk profiles.

The capital buffers are broadly in line with its projections, Fitch said.

The sector's impaired-loan ratio declined to 4.5 per cent in the first nine months of the financial year ending March 2023 (9MFY23), from 6 per cent at FY22 which is nearly 60 basis points (bp) of its FY23 estimate, Fitch said.

"Increased write-offs have been a key factor, but higher loan growth, supported by lower slippages and improved recoveries, have also played a role," Fitch said.

Fitch expects a further improvement by FYE23, although banks still face the risk of asset-quality pressure associated with the unwinding of loan forbearance in FY24.

The sector's improving provision cover (9MFY23: 75 per cent, FY22: 71 per cent) also supports banks' ability to withstand risks, although private banks are significantly better placed than state banks due to their lower impaired loan ratio of 2.1 per cent, against state banks' 5.6 per cent.

According to Fitch, sound economic momentum has contributed to a further drop in credit costs to 0.95 per cent at 9MFY23, as per its estimate, compared with 1.26 per cent at FY22.

Sustained high loan growth, accompanied by rising risk density, could pressure capital for the banks.

Private banks also demonstrate better access to the equity capital market, reflected in state banks' limited equity raising, preference for hybrid capital instruments and dependence on government recapitalisation.