Ind-Ra: Basel 3 Deadline Deferral Eases Immediate Capital Pressures for Banks

India Ratings & Research (Ind-Ra) says that the Reserve Bank of India's (RBI) deferral of the Basel 3 implementation deadline by a year has eased the pressure on banks to issue hybrid Tier 1 capital in FY15. This is a practical outcome of the current limited investor appetite for such instruments and the agency believes that the new deadlines do not dilute the spirit of Basel 3.

However, capital injection will remain a priority for Indian banks through the rest of this decade, as the total capital required during the migration to Basel 3 has only gone up due to the extra year added during the transition till March 2019. The government's commitment to maintain its majority shareholding in public sector banks assures them of steady equity injections. This underpins the support floor that Ind-Ra has on the Long-Term Issuer Rating of these banks.

The earlier guideline required banks to issue as much as INR260bn of hybrid Tier 1 in FY15, significantly more than the INR112bn of common equity tier 1 that the government has budgeted to inject during the year. While the capital requirement in FY15 has diminished significantly, the government is likely to maintain its schedule of injecting capital. For example, while the budgeted amount of INR112bn is now higher than the new requirement of under INR10bn equity by government banks during FY15, injecting the full amount will help reduce capital pressures in subsequent years. It can also help meet part of any shortfall in the hybrid Tier 1 requirement of INR134bn now estimated for FY15.

The revised guidelines have also tightened the loss absorption features of hybrid capital by eliminating the 'temporary' write-down feature in both hybrid Tier 1 and Tier 2 instruments. These instruments now can be either permanently written down or converted into equity, which improves the quality of capital by increasing any potential loss that investors may face. While the threshold trigger for Tier 1 instruments has been reduced slightly, this will be rolled back post-2019.

Developing a local market for hybrid instruments is therefore key, and regulators are examining the investment norms of insurance companies and pension funds to give them greater flexibility to invest in these instruments. As part of this market development exercise, investors will benefit from transparent and matured criteria for evaluating risks in these instruments, particularly by differentiating between a support-driven rating and the stand-alone credit profile of a bank.

Ind-Ra's approach to rating the hybrid debt capital of a bank remains unchanged following yesterday's revised guidelines. The agency will first evaluate the 'stand-alone' credit profile of the bank based on the strength of its balance sheet and future performance. The rating of a hybrid will be anchored around either the Long-Term Issuer Rating or the stand-alone credit profile, depending on whether the instrument absorbs losses on a 'gone-concern' or 'going-concern' basis. Any difference separating the hybrid rating from the anchor will depend upon Ind-Ra's views on the volatility of future performance and the likely need of extraordinary support to maintain the bank's viability.

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