Big Daddy banks will need to bulk up capital

The Reserve Bank of India’s proposed framework for domestic systemically important banks (D-SIB) may require the government to loosen its purse strings significantly to help public sector banks meet the additional capital requirements envisaged.

Among the criteria used by the RBI to shortlist such banks, size (in terms of asset size) is the main one with a 40 per cent weight.

Going by size alone, 12-14 banks could be categorised as systemically important. But some public sector banks, such as Central Bank, Union Bank and Canara Bank, may get filtered out when other criteria such as interconnectedness and complexity are also considered.

A holistic consideration of all the criteria would throw up, as likely candidates for the systemically important tag, the following: State Bank of India, Punjab National Bank, Bank of Baroda, ICICI Bank and HDFC Bank.

Foreign banks may not meet the size criterion but the RBI is likely to consider a few of them as systemically important, given their exposure to the derivatives market and specialised services. Citibank and Standard Chartered Bank may fit the bill here.

These likely ‘too-big-to-fail’ banks will be required to set aside more capital than their peers. Based on the category in which the bank falls, it has to set aside extra capital in the range of 0.2 per cent to 0.8 per cent by April 2019.

That may not be difficult for the private and foreign banks in the above list since they already have a strong capital adequacy ratio. Their core Tier 1 ratio (essentially the bank’s own equity) is 10-12 per cent, much above the mandated 6.5 per cent. Also, with likely strong earnings growth and good asset quality, meeting the new capital norms should not be a challenge, even in the future.

For now, public sector banks such as PNB, SBI and BOB are also comfortably capitalised with Tier 1 ratio of 8-9 per cent. But, given their slower pace of growth and concerns on asset quality, these banks will likely have to depend on the government to meet their capital needs in the coming years.

Based on a back-of-the-envelope calculation using various credit growth scenarios (12-18 per cent), public sector banks may need 10-15 per cent more capital than they would have otherwise required.

Their biggest shareholder, the government — already struggling to keep a tight leash on the fiscal deficit — may find it difficult to infuse this additional capital. Hopefully, good earnings growth and plough-back of these earnings by the public sector banks will reduce the amount of capital they need to raise. The proposed consolidation among the public sector banks, if it goes through, should also moderate the government’s contribution.

Nonetheless, the government will need to loosen its purse strings significantly. For one, it has not yet spelt out the amount earmarked for recapitalisation of public sector banks in 2014-15, though the Budget has acknowledged that as much as ₹2.4 lakh crore would be required by 2018.

In this context, the government’s plan to dilute stake in PSU banks is welcome and could provide a breather. The government’s share in state-owned banks varies between 55 per cent and 82 per cent. By paring its stake in some smaller banks, the government may be able to generate funds to meet at least a portion of the needs of some of the larger banks.