Wake-up call to government: Moody’s pegs PSBs’ capital need at Rs 2 lakh crore for next two years

Rating agency, Moody’s has given a wake up call to Narendra Modi government on the imminent capital burden required to fill the funding gap of India’s NPA-ridden, COVID-19-hit state-run banks. It has projected the capital required by government banks over the next two years around Rs 2 lakh crore.

“We estimate PSBs will need INR1.9 trillion-INR2.1 trillion ($25 billion-$28 billion) in external capital over the next two years to restore their loss absorbing buffers,” Moody’s said.

This is a reminder to the government, the majority owner in these banks, that it will have to find ways to generate money to refill the funding void of PSBs. Question is can a fiscally starved government take up the challenge.

In the last budget, union finance minister, Nirmala Sitharaman didn’t earmark any funds for banks except saying that the government wants PSBs to tap markets to fend for themselves. But the smaller banks struggling with weak balance sheets and the potentiality of a spike in bad loans going ahead aren’t able to find investors.

Being the majority stake holder in these banks, it is the responsibility of the government to find ways to keep these banks capital adequate.

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Moody’s has warned that a sharp slowdown in India's economic growth exacerbated the coronavirus outbreak will hurt PSBs asset quality, and result in sharp increases in credit costs, which will hurt profitability.

“Consequently, PSBs' already weak capital buffers will be depleted,” Moody’s said.

The most likely source of capital to plug the capital shortfalls will be government support, despite the completion of a large recapitalisation by the government several months ago, Moody’s said.

Moody’s has highlighted three major areas of importance with respect to PSBs: One, it has warned that banks’ asset quality will deteriorate going ahead.  The agency has cited that the Indian economy will contract sharply in fiscal year ending March 2021 (fiscal 2020) before returning to growth, though modestly, in fiscal 2021.

As a result, formation of new nonperforming loans (NPLs) will accelerate substantially, driven by the retail and micro, small and medium enterprises (MSME) segments, it said.

“Although one-time loan restructuring allowed by the Reserve Bank of India (RBI) will prevent a sudden increase in NPLs, NPLs and credit costs will increase in the next two years, hurting PSBs' already weak profitability and depleting their capitalisation,” Moody’s said.

Secondly, Moody’s said banks will face large capital shortfalls again as credit costs rise.

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Under the base scenario, Moody’s estimate of the total amount of estimated Rs 2 lakh crore for next two years, PSBs will need about Rs 1 lakh crore to build loan-loss provisions to about 70 percent of NPLs, which will leave them with enough capacity to grow loans 8 percent-10 percent annually, faster than the 4 percent in fiscal 2020.

“With a capital infusion of this magnitude, banks would also be able to maintain capitalisation at levels comparable to those of similarly rated peers globally, with Common Equity Tier 1 (CET1) ratios of at least 10 per cent,” Moody’s said.

Finally, to maintain financial stability, government will continue to provide capital support for PSBs, Moody’s said.

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“Uncertainty surrounding India's economic recovery as well as the ongoing cleanup of balance sheets are making it difficult for most PSBs to raise equity capital from markets. This means PSBs will continue to need support from the government to plug their capital shortfalls, and we expect the government to infuse fresh funds into them as it has done in the past,” Moody’s said.

“If PSBs, which dominate the banking system in India, fail to function properly in the absence of state capital support, the country will face a deepening credit crunch, hampering its economic recovery,” Moody’s said.

Banking sector is expecting a sharp increase in NPAs in the next one year on account of the twin impact of the general economic slowdown and Covid-19 on the economy. The RBI has projected the gross NPAs (non-performing assets) of the banking sector to go upto about 15 per cent by March, 2021 in a worst case scenario.

The impact of the COVID-19 is not yet visible in the banking system as the RBI-announced moratorium scheme is in effect till August 31.Even after five decades of bank nationalisation, government banks continue to be at the mercy of the government for survival capital every year. These banks continue to control at least 60 per cent of the assets in the banking system.

The government has so far refused to seriously take up the bank privatisation although it has made promises in the past. It has, however, initiated a drive last year to merge weaker PSBs with stronger ones.
In a recent interview with Moneycontrol, former RBI deputy governor, Viral Acharya had stressed the need for government to exit from the ownership of PSBs.

“Some public sector banks should be considered for re-privatisation. They can get more financial capital from the market and modernize with better technology, human capital and risk management. In the other ones also, government can cut stake below majority mark like several of the committees in the past have recommended,” Acharya said.

The ball is now in the court of the government whether to continue to with the ownership of these banks or let private money come in.