Fitch lowers banks’ capital needs estimate to Rs 4 L Cr by FY19 on weak loan growth

Indian banks are likely to require around USD 65 billion (approximately Rs 415,754 crore) of additional capital to meet new Basel III capital standards that will be fully implemented by the financial year ending March 2019 (FY19), according to Fitch Ratings' latest estimates.

The capital need estimates have fallen from their previous estimate of USD 90 billion (about Rs 575,580 crore) largely as a result of asset rationalisation and weaker-than-expected loan growth, said a report by the ratings agency.

Even so, state banks - which account for 95 percent of the estimated shortage - have limited options to raise the capital they still require and are likely to be dependent on the state to meet core capital requirements, said the report co-authored by Saswata Guha, Director and Jobin Jacob, Associate Director at Fitch Ratings India.

The government is committed to investing only another Rs 20,000 crore as fresh equity for 21 state banks over FY18 and FY19, having already provided most of the originally budgeted Rs 70,000 crore.

Fitch believes the government will have to pump in more than double, even on a bare minimum basis (excluding buffers), if it is to raise loan growth, address weak provision cover, and aid in effective NPL resolution - the gross NPA (non-performing asset) ratio reached 9.7 percent in FY17, up from 7.8 percent in FY16.

Given that public sector banks have already lost around 300 bps (basis points) in market share to private banks since FY12 due to insufficient state capital, poor growth performance has led to a decline in the total CET1 (common equity Tier-1) capital of state banks over the last year, despite the injections.

Fitch said that the prospects for internal capital generation are weak and low investor confidence impedes access to the equity capital market.

“Access to the Additional Tier 1 (AT1) capital market has improved in recent months - reflecting state support to help state banks avoid missing coupon payments - but around two-thirds of the capital shortage is in the form of common equity Tier 1 (CET1),” it said, adding that weak capital positions have a major negative influence on Indian banks' viability ratings, which will come under more pressure if the problem is not addressed.

Further, the NPA resolution process being led by the Reserve Bank of India (RBI) could potentially release capital if recovery rates are as high as banks and the government are hoping for.

Currently, there are 12 accounts, representing 25 percent of total system NPAs, in the resolution process at the insolvency courts. The RBI has also released a list of 50 more accounts that banks have been directed to resolve within three months or push into the insolvency process.

“Most banks do not expect haircuts to exceed 60 percent. However, those loss assumptions may look optimistic considering the first resolution of corporate debt under the government's new insolvency code produced a recovery rate of just 6 percent,” the report stated.

Banks argue this cannot be extrapolated to the other exposures, which they say are backed by more productive assets. Nevertheless, an average provision cover of 40-50 percent is quite low considering that the accounts in question have been NPAs for two or more years and are financially stretched. Lower-than-expected recoveries are likely to put earnings at risk, and capital could be further undermined as a result, it added.

Indian banks' loan growth slumped to 4.4 percent in FY17 - the lowest in several decades - and it is unlikely that state banks will grow at all in the foreseeable future given their capital constraints. Many state banks, particularly smaller ones, will struggle to survive as individual banks, and could be swept up into the government's consolidation agenda.