Linking capital infusion to performance can set off bank consolidation moves: ICRA

The new performance criteria for equity infusion into public sector banks (PSBs) could potentially lead to a shake-up (read: consolidation) in the Indian banking system, according to credit rating agency ICRA.

The new criteria, announced by the Centre on February 7, would consider the past performance of every PSB to determine its eligibility for equity infusion.

To be eligible, a PSB’s return on assets (RoA) must be better than the average for all PSBs for the past three years, and its return on equity (RoE) must be better than the average for the past one year.

Under the rather simplistic criteria, only nine out of 22 PSBs are eligible to receive equity from the Centre in 2014-15, with the rest 13 being “ineligible”. These “ineligible” banks would need about half the PSBs’ total requirement of ₹2.6-lakh crore in equity and around 40 per cent of the ₹1.4-lakh crore in Additional Tier I capital to meet their growth objectives and to comply with Basel III norms, the agency said. ICRA said while the new criteria would reduce the burden on the Government’s finances it is likely to be accompanied by “other” — possibly unintended — costs, which could be substantial.

Moreover, the new criteria reflect a dramatic shift from the past when Government support was a “given” and lent considerable support to PSBs’ credit profiles.

“While it may be argued that this approach led to complacency to an extent, it indeed was an anchor for the financial stability of PSBs, enabling many of them to extend credit to support economic activity when NPAs were high, profitability low and dependence on external capital infusion significant,” the agency said.

At the moment, when economic activity is yet to improve significantly and several infrastructure bottlenecks are still to be cleared, the loss of the “anchor” (capital support) is likely to cause a stir among PSBs, it added.

While capital markets do remain an option for raising equity, given the PSBs’ largely poor valuations and shareholding restrictions, the depth of this option appears limited.

While the intent of the new criteria is positive, there may be merit in broad-basing it and providing for a transition period.