CRISIL Ratings, India's leading rating agency, estimates that India's banks will need to raise Rs.2.7 trillion by March 2018 to meet Tier-I capital requirements under Basel III.
Developing bond markets critical to sustain banks' capitalisation, says CRISIL
CRISIL Ratings, India's leading rating agency, estimates that India's banks will need to raise Rs.2.7 trillion by March 2018 to meet Tier-I capital requirements under Basel III. Starting April 2013, Basel III guidelines on capital regulations issued by the Reserve Bank of India (RBI) will be implemented in a phased manner. The Tier-I capital requirement consists of two components - a minimum of Rs.1.3 trillion as equity capital and up to Rs.1.4 trillion as non-equity Tier-I capital. CRISIL believes that while India's banks are comfortably placed to raise the equity capital component, the key challenge lies in raising non-equity Tier-I capital, given that the instruments' features are riskier than under Basel II. CRISIL, therefore, believes that it is critical to develop bond markets to help banks raise the nonequity capital component. Moreover, banks will need to focus on conserving capital under Basel III.
Banks will face difficulties in raising Rs.1.4 trillion as non-equity Tier-I capital, as these instruments will carry higher risks, given their equity-like features; these include discretion on coupon payments, and likelihood of coupon non-payment and principal loss if a bank's equity capital falls below prespecified thresholds. Says Mr. Ramraj Pai, President, CRISIL Ratings, "This will limit investor appetite for such instruments. It will also reduce their attractiveness for banks, as these instruments will be costlier than those under Basel II. Nevertheless, non-equity Tier-I capital will still be cheaper than equity capital."
CRISIL believes that several measures need to be taken to address this challenge. The range and depth of investors in such instruments can be expanded through a structured bond market development plan. This could include alignment of investment norms for long-term investors such as insurance companies and provident funds. Adds Mr. Pai, "The Government of India (GoI) can consider investing in non-equity Tier-I instruments of public sector banks (PSBs) through the holding company for PSBs proposed by GoI, thereby developing market acceptance for such instruments."
Notwithstanding the challenges in raising non-equity Tier-I capital, CRISIL believes that Basel III will structurally strengthen the banking sector by enhancing the quantity and quality of banks' capital. This, coupled with RBI's strong regulatory supervision, will cushion banks from potential shocks, and reduce systemic risks. Says Mr. Suman Chowdhury, Director, CRISIL Ratings, "GoI's reaffirmation of its commitment to infuse capital in PSBs to meet Basel III norms can mitigate the risk of their equity capital falling below regulatory thresholds for potential loss absorption, thereby building investor confidence in these instruments."
India's banks are comfortably placed to raise the Rs.1.3 trillion equity capital under Basel III by March 2018, despite the equity capital requirement more than doubling to 8.0 per cent from 3.6 per cent under Basel II. This is primarily on account of expectation of continued capital support to PSBs from GoI, and the demonstrated capital-raising ability of private sector banks. Adds Mr. Chowdhury, "Banks, on their part, will need to focus on conserving capital, primarily by refinancing infrastructure loans that account for a sizeable chunk of their exposure."
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