PSB recap plan insufficient to support lending growth: Fitch

The Indian government's recent announcement that it will soon inject $7 billion into state-owned banks under its recapitalisation plan is likely to help banks meet minimum regulatory requirements, but is not sufficient to support significantly stronger lending growth, according to Fitch Ratings.

The global credit rating agency said a large proportion of the government's latest round of recapitalisation is still likely to go towards addressing regulatory shortfalls rather than to support asset growth.

More will be needed as a cushion against future losses at some state banks, as borrower defaults and slow bad loan resolution continue to put pressure on non-performing loan (NPL) provisions, it added.

State banks' provision cover ratio was around 50 per cent at end-September, still short of the 65 per cent that Fitch believes may ultimately be needed.

The agency observed that much of the capital already injected by the government into state banks over the last few years has been consumed by large financial losses caused by loan loss provisions.

The injections have allowed Allahabad Bank and Corporation Bank to leave the RBI's prompt corrective action (PCA) framework, following earlier exits by Bank of India, Bank of Maharashtra and Oriental Bank of Commerce. This frees these banks from tight restrictions on their management and growth.

However, Fitch underscored that leaving the PCA framework will not remove the constraints on growth imposed by weak capitalisation, unless the state injects more capital into these banks or there is a strong turnaround in profitability that supports internal capital generation, which looks unlikely.

Overall, the agency estimated that banks will need an additional $23 billion in 2019, after these latest injections, to sufficiently meet minimum Basel III capital standards, achieve 65 per cent NPL cover, and leave surplus capital for growth.

Capital needs have fallen from Fitch's estimate of $65 billion in September 2017, but progress has not been significant enough to spur loan growth.

The agency observed that the authorities' approach to the banking sector has clearly shifted towards spurring lending in recent months.

The Reserve Bank of India (RBI) in early January deferred the implementation of the final tranche of the capital conservation buffer (CCB) of 0.625 per cent to end-March 2020.

The RBI has also lowered risk weights for some lending to non-bank financial institutions, despite these companies facing increased liquidity stress in the past year.

These steps, along with capital injections, have eased but not removed capital constraints on state banks' growth, Fitch Ratings said in a statement.

The agency assessed that six of the 12 state banks that are due to receive the latest government capital injections were below the 7.375 per cent minimum common equity Tier-1 requirement as of end-December 2018. Three more are below the 8 per cent requirement that will apply from end-March 2020, assuming there are no further deferments of CCB implementation.

The government announced a $32-billion recapitalisation programme in October 2017, split between the fiscal year ending March 2018 (FY18) and FY19. It planned to provide $21 billion by issuing recapitalisation bonds and $3 billion from the budget, leaving the rest to be raised by banks from the equity capital markets. However, many state banks have been unable to access capital markets, and the government announced in December 2018 that it would provide an additional $6 billion. The latest injections represent the remainder of these previously allocated funds.

Fitch has a negative sector outlook on Indian banks, to reflect the near-term pressures from the sector's NPL stock and elevated credit costs on bank earnings and capitalisation. The absolute NPL and gross NPL ratios fell slightly in the nine months to December 2018 across many banks, but credit costs continue to outweigh weak income buffers.

The agency expects continued weakness in the near term, although substantial resolution of bad assets could put banks on a faster path to recovery.