Raising non-equity tier-I capital of Rs 1.4 lakh crore will be a key challenge under the Basel III requirement for Indian banks, according to a report by Crisil Ratings.
“Banks will face difficulties in raising non-equity tier-I capital, as these instruments will carry higher risks than those under Basel II, given their equity-like features,” said Pawan Agrawal, Senior Director, CRISIL Ratings.
Aimed at strengthening banks, Basel III requires them to maintain a much bigger capital base to absorb possible losses.
Costlier in new regime
The features of non-equity capital are discretion on coupon payments, likelihood of coupon non-payment and principal loss if a bank’s equity capital falls below the specified threshold of 8 per cent.
Ramraj Pai, President, Crisil Ratings, said, “This will limit investor appetite for such instruments. It will also reduce their attractiveness for banks, as these instruments will be costlier than those under Basel II. Nevertheless, non-equity tier-I capital will still be cheaper than equity capital.”
Pai said several measures need to be taken to address this challenge. The range and depth of investors in such instruments can be expanded through a structured bond market development plan. This could include alignment of investment norms for long-term investors such as insurance companies and provident funds.
“The Government can consider investing in non-equity tier-I instruments of public sector banks (PSBs) through the holding company for PSBs proposed by the Government, thereby developing market acceptance for such instruments,” he added.
Agrawal said that banks will need to focus on conserving capital under Basel III, primarily by refinancing infrastructure loans that account for a sizeable chunk of their exposure.
The ratings agency has estimated that Indian banks will need to raise Rs 2.7 lakh crore to meet tier-I capital requirements consisting of a minimum of Rs 1.3 lakh crore as equity capital and up to Rs 1.4 lakh crore as non-equity (debt instruments with loss-absorbing features) tier-I capital from April to March 2018 under Basel III guidelines issued by the Reserve Bank of India.
Of the Rs 2.7 lakh crore, public sector banks and private sector banks will be required to raise Rs 2.1 lakh crore and Rs 60,000 crore, respectively. Crisil made the estimates assuming 18 per cent growth of the banking sector for next five years.
Further, despite the equity capital requirement more than doubling to 8 per cent from 3.6 per cent under Basel II, Indian banks are comfortably placed to raise the Rs 1.3 lakh crore equity capital by March 2018.