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Moody's & ICRA: Differences between capital profiles of India's public and private sector banks will narrow; NPAs may peak in 2018

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Investors Service says that the gap between the capital profiles of Indian public and private sector banks is expected to narrow following the government's announcement of INR2.1 trillion ($32 billion) recapitalization plan for the public sector banks, which are financially the weaker entities.

Moreover, Indian affiliate says the deterioration in asset quality -- in terms of gross non-performing assets (GNPAs) -- may peak by FY2018, but elevated levels of provisioning on these NPAs will continue to negatively affect the banks during FY2018 and FY2019.

says the public sector banks' weak capitalization profile is their key credit weakness when compared to their peers in the private sector. As of September 2017, the average common equity tier 1 (CET1) ratio of rated public sector banks was 8.7% compared to 12.2% for the rated private sector banks. However, the gap is expected to narrow, given the government's recapitalization package. According to its 24 October 2017 announcement, the amount totals INR2.1 trillion ($32 billion), of which INR1.5 trillion ($23 billion) will come from the injection of public funds from the government's existing budget and the issuance of recapitalization bonds.

While details on capital allocations to individual banks are lacking at this stage from a top-down perspective, Moody's expects the government will allocate the INR1.5 trillion in capital across the country's 21 public sector banks so that they will all have common equity tier 1 (CET1) ratios above the minimum Basel III requirement of 8% by the end of March 2019, which is the end of fiscal 2019.

"The capital infusion will also help public sector banks build their provisioning coverage ratios as they will be able to allocate much of their operating profits towards loan-loss provisioning without having to worry about the impact on their capital positions," says Alka Anbarasu, a Moody's

"As such, Moody's expects the rated banks will achieve an average provision coverage of 70% by fiscal 2019, allowing them to take appropriate haircuts on problem assets. Such haircuts reflect one step in the regulator's efforts towards a thorough clean-up of balance sheets across these banks," says Anbarasu.

Accordingly, Moody's believes that the package will facilitate the two key policy initiatives of (i) non-performing loan (NPL) resolution and (ii) Basel III implementation. In addition, it will strengthen the government's bargaining position for pushing through some of its more fundamental reforms, such as those targeting corporate governance and industry consolidation.

Many public sector banks still suffer moral hazard issues that have led to lax underwriting standards.

Furthermore, government measures, such as the creation of the Board Bureau and separation of the banks' positions, have had a limited impact on the overall credit profiles of the banks, because they continue to struggle with large stocks of problem assets and weak capitalization, according to Moody's. Therefore, while the capital injection plan does not directly address governance problems in the system, it strengthens the government's bargaining power for pushing through some of these reforms.

Moody's also believes that with much greater visibility now regarding their future receipt of adequate capital from the government, it is possible that public sector banks may also regain market access. The share prices of most public sector banks improved ubstantially after the Indian government's October announcement of the recapitalization package. Already, in the last one month, a few public sector banks raised new capital from the equity capital markets.

Moody's notes significant scope for the government to reduce its current shareholdings in these banks and also maintain majority ownership.

Moody's Indian affiliate says that the pace of fresh NPA generation continues to moderate with an annualized rate of 3.9% for Q2 FY2018 against an annualized 5.0% for H1 FY2018 and 5.5% for FY2017.

estimates a rate of 3-4% for FY2018, which will translate into fresh slippages of INR2.5-3.0 trillion, and after adjustment for recoveries/upgrades and write-offs, GNPAs are likely to increase to INR8.8-9.0 trillion (GNPA of 10.0-10.2%) by the end of FY2018 compared to INR7.65 trillion (GNPA of 9.5%) at the end of FY2017.

While the GNPAs are likely to peak by the end of FY2018, the negative impact arising from elevated provision levels for weak assets is likely to continue until FY2019, says ICRA. The pace of NPA resolution has accelerated over the last six months with the Reserve of (RBI) directing banks to initiate proceedings under the insolvency and bankruptcy code (IBC) 2016 against stressed borrowers as well as make higher provisions on these stressed accounts.

ICRA believes that with 1/3rd of GNPAs already identified for resolution under IBC, credit provisioning surged during Q2 FY2018 with a 40% increase on a sequential basis and a 30% increase on a Y-o-Y basis. With the public sector banks accounting for almost 88% of GNPAs, the ability and willingness of these banks to resolve these stressed accounts has also improved following the government's announcement on their recapitalisation.

"ICRA expects their credit provisions for the sector to surge to INR2.4-2.6 trillion during FY2018 against INR 2.0 trillion during FY2017. For public sector banks, the credit provisions are estimated to increase to INR2.0-2.2 trillion during FY2018 from INR1.6 trillion during FY2017," said Karthik Srinivasan, ICRA's

With the credit provisioning of the public sector banks significantly higher than core operating profitability, ICRA estimates that they will report losses of INR300-400 billion during FY2018 as against INR70 billion during FY2017.

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(This story has not been edited by Business Standard staff and is auto-generated from a syndicated feed.)

First Published: Wed, January 10 2018. 16:52 IST
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