Filling the hole
Such is the shortage of capital at Indian banks that resorting to the public markets may not enough to plug the gap and more radical solutions may be necessary.
By any measure, Indian banks are badly in need of more capital. Fitch Ratings has come up with an eye-popping estimate of US$140bn for all kinds of capital, while Standard Chartered sees the need for as much as US$53.4bn in Common Equity Tier 1.
Indian banks have until 2019 to meet Basel III capital requirements in full. However, the capital shortage has been apparent for years and, to date, there has been little notable progress to remedy the situation. While banks around the world have taken drastic measures to reduce risk-weighted assets and issue various flavours of capital via the public markets, Indian lenders have stayed conspicuously behind. Bankers and analysts blame this partially on frequent managerial changes at some of these lenders, as well as worsening non-performing loan levels, but warn that concrete steps need to be taken over the next 12 months or the capital hole may become even larger.
The Indian government has pledged to inject US$11bn over the next four years, but not many in the market believe this will be even close to enough. In September, the Reserve Bank of India designated only two lenders as domestically systemically important banks (DSIBs) in a move that analysts said only emphasised the scale of the problem. DSIBs are required to have higher capital buffers than smaller lenders. So, the fewer DSIBs there are in the country, the less capital is needed.
“It’s hard to know where the equity capital will come from other than the government, other than for a few large public sector banks that have reasonable return metrics.”
“The extent of the equity capital requirement is debatable, but these banks will still have challenges obtaining that capital,” said Pramod Shenoi, head of capital solutions DCM and FIG at Standard Chartered. “It’s hard to know where the equity capital will come from other than the government, other than for a few large public sector banks that have reasonable return metrics. However, the NPL situation is getting worse and the economy is not really moving, only compounding the difficulties for the public sector banks.”
The bulk of the capital need is related to India’s public sector lenders, which account for 75% of the country’s banking assets. Private banks are already reasonably well capitalised. Of the public-sector banks, the smaller and less profitable lenders are seen as those facing the most trouble.
Syndicate bankers say the larger institutions will be able to tap shareholders through rights issues or offerings of Additional Tier 1 or Tier 2 bonds, but smaller lenders will find these avenues difficult to tap. They see lower-tier pubic banks having to pay premiums as high as 100b, and, even then, still struggle to attract investors. Furthermore, if all banks try to access the capital market at the same time, there is a chance that financing will become even more expensive.
On the equity side, Indian law states that public-sector banks must be at least 52% state owned, making share dilution impossible as many of these lenders hover around the threshold.
As tapping capital markets will be difficult, analysts hope that either the government will pledge to inject more capital into the system or Indian banks will begin a long-overdue process of consolidation, with stronger lenders merging with weaker ones.
After years of dithering, the recent deterioration in credit quality may spark some sense of urgency. NPLs at Indian banks hit 13% of total loans this year, according to a recent research note from the RBI. The figure has risen steadily over the last four years from just over 6% in 2011. For private banks, the ratio is a more reasonable 4%.
Analysts point out that this presents the government and the banks with something of a Catch-22 situation. The NPL ratio is rising because of a number of factors, but primarily because a slowing economy is making it harder for companies to pay back debts. Although a faster-growing economy will improve the NPL situation as it will help struggling companies recover, it will also likely cause risk-weighted assets to rise as credit demand grows, resulting in higher capital requirements.
“We believe around 11%–12% of loans are stressed,” said Geeta Chugh, a senior direct at Standard and Poor’s. “A large part of that is from infrastructure, metals and mining and we’re starting to see more NPLs from the sugar and textiles areas. The economic recovery and resolution of policy issues, such as land acquisitions, fuel availability for power projects, appropriate pricing of electricity, are vital for the NPL resolution. Having said that, the economic recovery will likely increase the capital requirements of the banks as it is likely to be accompanied by high credit growth.”
As such, many bankers and analysts on the ground say the capital shortfall is merely a symptom of a bigger problem. They argue that further capital injections or fundraisings are merely avoiding the fundamental issue that many of the public-sector banks are not profitable, with a crying need for restructuring, and bleed the government for more funding year after year. Fitch calculates that their overall return on equity has fallen from 17% in 2011 to 8% this year. Many trade below book values.
“At this point, it’s obvious to many that we need to see more of these banks go private and for there to be some mergers and acquisitions,” said a syndicate banker. “The capital gap is too big for them all to tap the market and the government cannot keep throwing money at this problem.”