Fitch Ratings on Tuesday said capital needs of Indian banks have fallen from its previous estimate of $90 billion to $65 billion, largely as a result of asset rationalisation and weaker-than-expected loan growth.

According to the credit rating agency's latest estimates, Indian banks are likely to require around $65 billion of additional capital to meet new Basel III capital standards that will be fully implemented by the financial year ending March 2019.

Fitch said though capital needs have fallen, state-run banks, which account for 95 per cent of the estimated shortage, have limited options to raise the capital they still require. Prospects for internal capital generation are weak and low investor confidence impedes access to the equity capital market, it added.

State support

The agency observed that 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).

However, 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.

“State banks are likely to be dependent on the state to meet core capital requirements. The government is committed to investing only another $3 billion in fresh equity for 21 state banks over FY18 and FY19, having already provided most of the originally budgeted $11 billion,” said the agency.

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 non-performing loan (NPL) resolution — the gross NPL ratio reached 9.7 per cent in FY17, up from 7.8 per cent in FY16.

Resolving NPAs

The agency felt that the NPL 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.

There are 12 large accounts currently going through resolution, representing 25 per cent of total system NPLs, and the RBI has recently released a list of 50 more accounts that banks have been directed to resolve within three months or push them into the insolvency process.

“Most banks do not expect haircuts to exceed 60 per cent. 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 per cent.

“Banks argue this cannot be extrapolated to the other exposures, which they say are backed by more productive assets,” said Fitch.

Nevertheless, average provision cover of 40-50 per cent is quite low considering that the accounts in question have been NPLs 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, the agency added.

Fitch said state banks are unlikely to be freed from their current gridlock unless NPL resolution is accompanied by additional capital.

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