RBI move a temporary fix to PSBs' woes

Investors likely to shy away from most of these lenders, as challenges on growth, asset quality, capital constraints continue

The Street has cheered the Reserve Bank of India's move, announced on Tuesday evening, to ease the capitalisation norms of banks, both public and private. However, this only buys time, aver observers, to address the more fundamental issues.

To align the definition of capital with Basel-III standards, RBI allowed banks to include three balance sheet items as CET-1 capital or core equity capital. These are revaluation reserves (on a bank’s property) at a discount of 55 per cent, foreign currency translation reserves arising out of translating revenues/earnings from foreign businesses in local currency (at a 25 per cent discount) and Deferred Tax Assets on account of timing differences (capped at 10 per cent of CET-1).

“This is a step in the right direction and augurs well for public sector banks (PSBs) already reeling under capital constraints like Union Bank, State Bank of India (SBI), Indian Overseas Bank (IOB) and Bank of India (BoI),” says Nilesh Parikh of Edelweiss Securities.

The reclassification will push the CET-1 ratios of banks (private and public) by 15 to 100 basis points (bps), estimate analysts at MOSL. Notably, PSBs needed $30-40 billion over FY16-19 to comply with Basel-III norms. Of these, government has allocated about $10 bn for capitalisation of PSBs. Analysts at Ambit Capital estimate that if the government stake in these falls to 52 per cent from the present average of 65 per cent, PSBs, at current valuations, can raise capital of $9 bn.

“With the capital release of $4-5 bn from RBI’s measures taken yesterday, PSBs' capital shortfall can shrink to $5-15 bn from $10-20 bn earlier,” adds Ravi Singh of Ambit Capital.

However, this move appears to be a short-term fix. PSBs are likely to make significant provisioning for bad loans in the March quarter and this could put additional pressure on their capital requirement, earnings and valuations. The move does not address the core issues of profitable growth and asset quality. The Street will also be watching for monetisation of non-core assets, which would reduce the dilution risk for these banks. Unless the core performance of PSBs improves sustainably, it will be difficult to raise funds from investors.

Analysts at Kotak Institutional Equities believe there is a high risk of investors or rating agencies looking at these capital structures with scepticism and to start excluding these changes. They believe smaller PSBs such as Corporation Bank, Dena Bank, IOB and IDBI Bank stand to gain from the move. Among the larger ones, SBI has indicated it could have a revaluation of Rs 20,000 crore, augmenting its CET-1 ratio by 60-70 bps.

The scepticism is because the tier-I capital of banks is expected to comprise funds that can absorb business losses. This is unlikely if it is boosted by revaluing assets that might or might not be sold, said an analyst with a domestic brokerage.

PSBs' ability to create adequate cover for bad debts, compete and grow profitably will continue to be under pressure, say analysts.

The shares of SBI, Bank of Baroda (BoB), Punjab National Bank and BoI saw gains following RBI’s move to ease the capitalisation norms. These stocks were up by five to 12 per cent on Wednesday versus a two per cent gain in the benchmark S&P BSE Sensex. Even so, analysts do not recommend most PSBs. They prefer larger names such as SBI or BoB, given their relatively superior financials.

While private banks will also gain from RBI's move, majority of them don't have any serious asset quality issues. Consequently, analysts remain positive on private banks, which are also better placed to gain from any recovery in economic and credit growth.