Operating profitability (pre-provisioning profitability, or PPoP) of banks should stabilise by the end of this fiscal, mainly driven by improvement in the net interest income. This will be supported by lower interest reversals on non-performing assets (NPAs), pick-up in credit growth, and reduction in funding costs.

However, with the economic value of assets underlying NPAs eroding with time-resolutions are hard to come by-banks would do well to bite the bullet and step up on provisioning, mainly for large corporate NPAs, and thus facilitate faster clean-up of their balance sheets.

CRISIL estimates banks would need to set aside close to Rs 3.3 lakh crore this fiscal, or 50% more than the Rs 2.2 lakh crore they provided for last fiscal.

The provisioning quantum was arrived at after an account-by-account analysis of the economic value of assets underlying large corporate NPAs. The analysis also showed that potential write-downs could be in the 25% to 75% range.

While some of the NPA accounts have been adequately provided for, the majority of them will require higher provisioning compared with current levels, based on the residual economic value of the assets.

CRISIL estimates this could lead to a net loss of ~Rs 600 billion for the banking sector this fiscal with public sector banks (PSBs) bearing the brunt of increase in provisions and the resultant impact on profitability because of their higher stock of NPAs.

The assessment also assumes effective resolution of stressed assets this fiscal. Any delay would extend the pain on profitability into the next fiscal, too.

''Pressure on the earnings profiles of banks would reduce from next fiscal if banks increase provisioning on large corporate NPAs this fiscal,'' said Krishnan Sitaraman, Senior Director, Ratings, CRISIL. ''Stabilisation in operating profitability and mitigation of asset quality stress would then set the stage for earnings revival, especially of PSBs, as they focus more on credit growth.'' PSBs will be the most affected because their PPoP may not be enough to facilitate a step-up in provisioning.

That's because their net interest margins are lower and growth in fee income is expected to be suboptimal this fiscal. Any kicker from treasury profits, as had happened last fiscal, could partly offset the provisioning impact on profitability.

''The ability of PSBs to step up on provisioning and hasten clean-up of balance sheets would depend on their capital strength to absorb P&L losses,'' said Vydianathan Ramaswamy, Associate Director Ratings, CRISIL. ''While larger PSBs are better placed on this count, most of the medium and small ones will require relatively higher capital support from the government to offset such losses and also meet the capital requirements under Basel III regulations.''