The recent attempt by a few public banks to raise equity capital from the markets saw a relatively tepid response with participation largely limited to a few state-run institutions, raising questions on the ability of these banks to raise external capital. This is the situation despite the massive recapitalisation of public banks entailing a capital infusion of Rs. 3.16 lakh crore during FY2016-2020. Given the weak profitability outlook for these banks even in FY2022, the investors’ interest towards these banks is likely to remain muted. Increasing credit growth from the banking system would require active participation from public banks as they still account for 2/3rd of the banking sector credit. Accordingly, the Government of India (GoI) may need to continue supporting these banks in FY2022 as well.
At the beginning of the COVID-19-induced stress, ICRA estimated that the capital requirements for public banks could be as high as Rs. 80,000 crore for FY2021. However, various regulatory measures such as the moratorium, one-time restructuring, and the Emergency Credit Line Guarantee Scheme, are now expected to spread out the asset quality pressure over a longer period instead of only FY2021. As a result, the banks will have the option to provide for these stressed assets through their operating profits over the next couple of years, thereby reducing the need for raising capital immediately. Hence, ICRA expects that the budgeted capital of Rs 20,000 crore along with the external equity raise of around Rs 7,500 crore by a few public sector banks (PSBs) will be sufficient for public banks for the current financial year.
With sizeable capital infusion during the last few years, the financial profile of these banks has improved, though it can still be termed as below average in relation to private banks. While the core equity capital ratio improved to 9.7 percent, the net non-performing assets (NPAs) declined to 2.9 percent and the solvency (net NPA/core capital) improved to 33 percent as on September 30, 2020, from 8.4 percent, 7.2 percent, and 95 percent, respectively, as on March 31, 2018.
With reduced net NPAs and hence future provisions on legacy NPAs, ICRA expects that the public banks will be able to absorb their credit losses through their operating profits, thereby limiting large capital erosion in FY2021 and FY2022. Against cumulative losses of Rs. 2.37 lakh crore during FY2016-2020, ICRA expects that the public banks could be largely able to offset the expected losses through the budgeted capital allocation of Rs. 20,000 crore for FY2021.
For FY2022, ICRA expects the public banks to break even in a worst-case scenario as well with the possibility of a return on equity (RoE) of ~5 percent in a favourable scenario, which means that their capital requirements will be lower because of the losses. The capital requirements would, however, arise on account of the estimated Rs 23,000-crore Additional Tier I (AT-I) bonds where a call option would fall due next year. Hence, public banks will require capital not only for growth but also to replace these bonds to maintain their capital profiles. Factoring in the above two requirements, ICRA estimates the capital requirements for public banks to be negligible in a favourable scenario (RoE of 5 percent), but up to Rs 43,000 crore in a worst-case scenario.
The appetite of investors towards the AT-I bonds of public banks has improved recently with more public banks issuing AT-I bonds in FY2021 compared to FY2020. If the banks can raise a part of the Rs 43,000-crore capital through AT-Is and market sources, it could reduce the GoI’s recapitalisation burden for the coming fiscal. Though clarity is likely to emerge on this front only in H2 FY2022, ICRA expects that the GoI allocates some quantum to the PSBs in the Budget itself (unlike last year when they made the announcement later) to provide some additional comfort to the markets.
Though the GoI as a backstop for capital requirements does add to the comfort of public banks for their regulatory capital requirements, their weak capital position and the inability to raise capital from the markets have much larger consequences. As public banks garner a sizeable chunk of domestic savings, their ability to deploy these towards productive assets depends on their capital position. Uncertainty on the capital position keeps these banks in capital conservation mode, which can choke the credit supply and is not good for economic growth.