State-run banks may have a tough time ahead

Raising capital wouldn’t be an easy task for state-run banks as seen in the recent offering of State Bank of India to qualified institutional investors, which received a tepid response. Photo: Hemant Mishra/Mint

Dineshunikrishnan :Live Mint ;: MON, MAR 03 2014. 12 16 AM

Rising bad debt, huge capital requirements to meet Basel III norms likely to crimp growth of state-owned banks

Mumbai: A rising pile of bad loans, huge capital requirements to stick to the international Basel III norms and the inability of a cash-strapped government to fork out funds are likely to severely crimp growth of India’s state-owned banks.

State-run banks, crippled by capital constraints, will find it difficult to face competition from deep-pocketed private and foreign rivals and the new set of banks about to enter India’s Rs.83 trillion banking industry, experts warned.

While the capital needs of public sector banks are huge, the interim budget announced by finance minister P. Chidambaram earmarked only Rs.11,200 crore for them in fiscal year 2014-15, even lower than the Rs.14,000 crore in the year to 31 March. This led to immediate warnings from rating agencies, which cautioned that the limited capital infusion is credit-negative for these entities, against the backdrop of rising capital requirements.

An analysis of 40-listed state-run banks showed that at least seven public sector banks have equity capital adequacy ratio less than 8%. These are IDBI Bank Ltd (7.93%), Allahabad Bank (7.68%), Canara Bank (7.48%), Indian Overseas Bank (7.48%), Uco Bank Ltd (7.26%), Union Bank of India(6.75%) and United Bank of India (5.59%).

United Bank is already facing a crisis with its total bad loans rising to nearly 11%, and the bank’s overall capital adequacy ratio falling to 9.01%, forcing it to stop lending operations and virtually seek a government bailout. Experts expect that the government will need to infuse at least Rs.1,000 crore in funds into the bank, over and above what it was originally supposed to receive under the annual share of capital from the government.

A core capital adequacy of less than 8% doesn’t imply that a bank is in any form of trouble, but their capital position is relatively weaker than other banks, which could impact their ability to grow their business.

Of these seven banks, the government owns above 75% in three banks, and between 58% to 69% in the rest.

Warning signals

State-run banks will find it tough to grow their business and face competition, besides meeting the Basel III capital requirements, unless the government allows them to raise capital by bringing down its stake, experts said.

“It is a inflection point,” said Naresh Makhijani, partner, financial services, at consulting firm KPMG India. “The big question is that how will the government, which is running in a deficit, find money to infuse in government banks unless it reduces stake? Capital is going to be a major issue.”

The government expects to contain it’s fiscal deficit for 2013-14 at 4.6%, and has set a fiscal deficit target of 4.1% for 2014-15, suggesting that its ability to set aside additional capital for banks is limited.

But the government has also been reluctant to bring down its stake in public sector banks. “There will be no dilution of government’s shareholding,” Chidambaram said on 23 October in Delhi, responding to questions on capital infusion.

On 24 February, Moody’s Investors Services said the capital allocation made as part of the interim budget is “much smaller” than its estimate of theRs.25,000-36,000 crore required by India’s public sector banks to meet a minimum equity capital ratio of 8% under Basel III norms by 2018.

Under Basel III norms, which are being implemented in phases between April 2013 and March 2018, banks need to have a 8% core capital ratio and total capital adequacy ratio of 11.5% against 9% prescribed now, including a capital conservation buffer of 2.5%. Such a buffer is built by banks in good times to be used only in times of economic or system-wide downturns.

In February, this year, the Reserve Bank of India (RBI) permitted banks to use one-third of the amount banks have set aside as counter-cyclical buffers to make provisions against bad loans—the first time since the reserves were created starting 2010, implicitly acknowledging that mounting bad loans are a systemic concern. RBI’s concern is justified going by the sharp surge in bad loans in recent years and the resultant pressure on the capital adequacy of banks.

Gross non-performing assets (NPAs) of Indian banks rose to Rs.2.4 trillion in the December quarter, while another Rs.4 trillion is being restructured for stressed borrowers. Together, such loans constitute at least 11% of the total advances of Indian banks. Banks need to make 5% provisions for new restructured loans and the provision can shoot up drastically if the loan turn bad.

“Indian PSBs’ (public sector banks) need for significant external capital is a result of an increase in non-performing loans owing to the country’s slowing economy and infrastructure bottlenecks, and profitability that is insufficient for internal capital generation to fund loan growth,” Moody’s said, adding that it expects bad loans to continue rising in fiscal 2015.

Huge burden

“Indian banks will need sizable capital to support growth and meet Basel III requirements. Rated private sector banks are better placed than their public sector peers in terms of meeting Basel III capital requirements,” said rating agency Standard and Poor’s in its banking outlook for 2014 released on 10 February.

The agency expects weakness in banks’ asset quality to persist for the next 12 months given the tepid economic growth, and adds that capital is going to be a major challenge.

“Public sector banks will have to rely on a combination of government capital infusion and equity markets to support their capitalization.”

If the government opts to maintain its shareholding at the current level, the burden of recapitalization to meet Basel III norms will be of the order ofRs.90,000 crore, while on the other hand, if the government decides to reduce its shareholding in every bank to a minimum of 51%, the burden reduces to under Rs.70,000 crore, according to an RBI estimate in September 2012.

“No one would want to maintain the minimum capital in a highly competitive market. Government banks with a weaker capital base will either have to sacrifice their growth or will raise capital from market, which will further dilute their book value,” said Vaibhav Agrawal, vice-president, banking research,Angel Broking Ltd.

Raising capital wouldn’t be an easy task for state-run banks as seen in the recent offering of State Bank of India to qualified institutional investors, which received a tepid response.

As against the targeted Rs.9,600, the bank managed to raise only Rs.8,032 crore, with a state-owned Life Insurance Corporation of India bailing out the issue by buying 41.3% of the total shares offered.