In a move that can increase the cost of overseas borrowing for State Bank of India (SBI), credit rating agency Moody's has downgraded the bank's bank financial strength rating. The rationale was explained as slippage in asset quality and low capital adequacy.
While SBI's stock fell by 4 per cent, the market reaction seems to be overdone as borrowings outside India accounts for only 5.4 per cent of SBI's balance sheet. Though this move can increase the cost of re-financing and incremental borrowings, it would not entirely plug all avenues of funding for the bank. And then only around 16 per cent of the overall foreign currency liabilities (which may include deposits) are coming up for maturity by the end of this fiscal.
Asset quality
At the end of June 2011, the net non-performing asset (NPA) ratio of the bank was 1.6 per cent. Even if one assumes that all the restructured assets will turn bad, the overall ratio would only go up to 5.3 per cent.
We have not considered gross NPAs as a part of it is already provided from the profits and Tier-1 is arrived after excluding it. The net NPA ratio to tier-1 ratio works out to 18 per cent which is not alarming.
In addition to this if there are any slippages, the provisions in September quarter will take care of it. Even if the asset quality pressure persists, the incremental provisions that would be needed will be to the tune of 15-25 per cent of the sub-standard assets. This provision will wipe out profits in only extreme stress scenario like the one Moody's has mentioned. .
Capital infusion
The urgent need for SBI now is capital infusion.
After taking a contrarian decision to write-off reserves to provide for pension liability, the bank has witnessed its Tier-1 capital erode. This coupled with fall in profitability puts pressure on future loan book growth. Given this backdrop, infusion is necessary for SBI.
Additionally, Moody's analysis of the ratio of tier-1 capital to total risk-weighted assets declining in three years, is in-line with our expectation. The government has got to move fast now to infuse capital.
As Moody's time-line is three years for the capital ratio to fall to 8 per cent, Government financial standing may improve by then leading to further infusions. Additionally, the innovative debt instruments and preference shares can also be tapped during this time to bolster capital.