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24 May, 2019 10:43 IST
India's planned capital infusions are enough to resolve regulatory needs: Moody's & ICRA
Source: IRIS | 08 Jun, 2018, 09.52AM
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Moody's Investors Service expects the Indian government's (rated Baa2 stable by Moody's) recapitalization plan will still broadly resolve the regulatory capital needs of the country's 21 public sector banks (PSBs) and help augment the banks' loan-loss buffers, but will be insufficient to support credit growth.

Moody's Indian affiliate, ICRA Limited, says that with the accelerated recognition of stressed assets during FY2018, the asset quality problems of the banking sector peaked in March 2018.

"The PSBs' capital shortfalls are larger than the scale that the government had expected when it announced the recapitalization in October 2017, mainly because the banks have failed to raise additional capital from the market and it may be difficult for them to raise more capital given the substantial decline in their share prices since the beginning of 2018," says Alka Anbarasu, a Moody's Vice President and Senior Credit Officer.

"Moreover, the capacity of these 21 banks to generate internal capital has deteriorated because of their weak financial performance and a sharp increase in government bond yields, which hurt their investment income," says Anbarasu.

Furthermore, the discovery of Rs 14.4 billion of fraudulent transactions at Punjab National Bank (rated Ba1 stable, b1 by Moody's) has substantially increased the capital needs of that bank.

Under its recapitalization plan, the government plans to infuse Rs 650 billion into the PSBs in fiscal 2019, following the Rs 900 billion infused in fiscal 2018.

According to Moody's scenario analysis, after the budgeted capital infusion of Rs 650 billion, all PSBs will have Common Equity Tier 1 (CET1) ratios exceeding the 8% minimum, by March 2019. However, this development assumes overall credit growth for the PSBs of a modest 6%-8% in the next year, with the relatively stronger banks having room to grow, but the weaker institutions continuing to shrink their balance sheets to conserve capital.

As such, Moody's believes a key variable to the quantum of capital infusions is the government's own policy decision on whether it wants a higher level of credit growth in the system, given the potential macro-economic implications.

In addition, as per Moody's assumption that the banks allocate the bulk of their operating profits to loan loss reserves, the capitalization plan will support a provisions coverage ratio of about 60-62%, excluding general provisions. This level of provisioning coverage will be a significant improvement compared to the average coverage of about 49% (excluding general provisions) in fiscal 2018. Nevertheless, the sufficiency of the provisioning will depend on the write-downs the banks need to take under the Reserve Bank of India's (RBI) new rules for accelerated bad debt resolution.

In particular, Moody's expects write-downs related to the resolution of non-performing loans (NPLs) in the power and construction sectors could be larger than the outcome of the initial resolution of a few steel sector NPLs.

Also when unveiling its capital support plan in October 2017, the government had anticipated that the banks would raise about Rs 580 billion from the equity market. However, they have so far raised only about Rs 100 billion.

Moody's believes it may be difficult for them to raise significantly more, after consideration of the substantial decline in their share prices since the beginning of 2018, which indicates weak investor demand for Indian bank equities. The share prices of the PSBs has declined by 19% since beginning of the year, compared to a 3% increase in the Bombay stock market index.
According to Moody's, a key negative credit implication of these developments is that the capital allocations for relatively better run PSBs - like State Bank of India (rated Baa2 stable, ba1 by Moody's), Bank of Baroda (rated Baa3 stable, ba2 by Moody's), Canara Bank (rated Baa3 stable, ba3 by Moody's) and Syndicate Bank (rated Baa3 stable, ba3 by Moody's) - will decrease as the capital needs of the other banks have increased.

Although, these banks already have capital ratios exceeding minimum requirements, Moody's further expects them to generate capital internally. Nevertheless, lower capital allocations will leave them with less-than-expected capital to use for growth.

On the other hand, Moody's expects the remaining group of relatively weaker banks will still meet their Basel III requirements as the government is committed to helping the banks achieve their regulatory capital requirements.

Moody's Indian affiliate ICRA says that, with the accelerated recognition of stressed assets during FY2018, the asset quality problems of the banks peaked in March 2018 and further additions to gross non-performing assets (GNPAs) will decline with fresh slippages falling to around 3.0% during FY2019 compared to 7.1% during FY2018 and 5.5% during FY2017.

"The regulatory push for the recognition and resolution of stressed assets stepped up further during Q4FY2018 as the RBI announced the revised framework for the resolution of stressed assets during February 2018," says Karthik Srinivasan, Senior Vice President, Group Head - Financial Sector Ratings, ICRA.

"With the revised framework, all the regulatory forbearances were done away with and the threshold for the implementation of the resolution of stressed assets was further enhanced to a single day overdue status of the borrower," says Srinivasan.

ICRA believes that with these changes, the recognition of stressed assets further accelerated with fresh slippages for the sector being the highest ever for a quarter at INR2.28 trillion during Q4 FY2018 (a fresh NPA generation rate of 12%), with 85% from the PSBs.

With limited improvements in recoveries and upgrades, GNPAs surged to Rs 10.2 trillion (11.8%) on March 31, 2018 compared to Rs 7.65 trillion (9.5%) on March 31, 2017.

The sharp rise in fresh slippages, ageing of earlier NPAs because of limited resolution, and higher provisioning requirements on certain accounts referred for resolution under the insolvency and bankruptcy code (IBC) 2016 pushed up credit provisions for the sector, says ICRA.

This provisioning rose to Rs 3.17 trillion (4.0% of advances) during FY2018 as compared to Rs 2.03 trillion (2.7%) during FY2017, far surpassing the operating profits of the banks. The net losses for the sector increased to Rs 463 billion during FY2018 compared to net profit of Rs 350 billion during FY2017.

With the likely resolution of large stressed borrowers under the insolvency and bankruptcy code (IBC) 2016 and proposed resolution under the revised framework for resolution of stressed assets, ICRA expects the recoveries and upgrades to surpass the fresh addition to GNPAs during FY2019. This is expected in turn to result in a decline in the GNPAs and net NPAs to below 9% and 5% respectively by March 2019.

With recognition of the stress and higher provisioning, the provisioning cover against the NPAs increased to 49.4% in March 2018 compared to 44.3% in March 2017. Incrementally, assuming provision cover of 60-65% on the NPAs, the credit provisions are expected to decline to ~Rs 1.4-1.9 trillion (1.6-2.1% of advances) during FY2019.

Though the provisions are expected to decline, ICRA believes these are expected to surpass the operating profits of the PSBs, which will result in continued losses for them, even as the profitability of the private banks improves during FY2019.

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