Lack of Capital Could Limit PSB Growth at 9% CAGR over FY16-FY19, Slowest in Last Two Decades

Limited availability of growth capital for public sector banks (PSBs) could pull down their loan growth trajectories to a CAGR of 9% over FY16-FY19, says India Ratings and Research (Ind-Ra). This growth is the bare minimum needed to generate sufficient spreads that can absorb Ind-Ra's expected operating and credit costs over this period. The growth is likely to be lower at 8.1% over FY16-FY19 for mid-sized PSBs with a few banks witnessing a loan book decline. Even for this growth, Ind-Ra estimates the average Tier-1 capital needed during FY17-FY19 to be around 22% of FYE16 CET (36% for mid-sized PSBs). This estimate is over and above the capital committed under Indradhanush programme.

While Ind-Ra's expectation of limited credit demand beyond the refinancing requirements of levered corporates appears to be largely in line with the estimated credit supply for FY17, a sustained moderation in PSBs' credit growth is likely to start impacting the nominal gross domestic product pick-up for FY18-FY19.

The agency expects NPL aging to keep credit costs for PSBs at elevated levels of 170-180 bps in FY17 (280bp in FY16), continuing the pressure on profitability. Consequently, some PSBs would continue to report losses in FY17. Following the asset quality review (AQR) by the Reserve Bank of India in 1HFY16, a sizeable proportion of NPLs (including slippages from FY15) is likely to shift to the next classification bucket over FY17-FY18, attracting higher provisioning. The quantum of fresh slippages from the large corporate exposure may come down during FY17-FY18.

Ind-Ra expects un-provided non-fund-based exposures of large stressed accounts to continue to pose a threat to profitability for FY17FY18. However, the AQR exercise has ensured recognition of impaired loans and higher provisioning for cyclical sectors in deep stress, such as iron & steel, and a large proportion of stressed corporates that are yet to be provided for now belong to the infrastructure sector. Hence, stress resolution with a going concern approach (such as the S4A scheme) may prove to be effective.

Ind-Ra's support floor for PSBs remains unchanged as the agency expects (even under severe stress scenario) the potential equity requirement (or the bailout cost), to avoid approaching the point of non-viability triggers, to be manageable at INR85bn-INR100bn. This could, however, change if the government of India changes its support stance.

Ind-Ra believes that the chances of AT1 coupon deferral remain high for banks with depleted reserves. Elevated credit costs are likely to keep profits subdued which would put PSBs with low, or in some cases non-existent, revenue reserves under pressure. However, Ind-Ra believes that the ability to service AT1 bonds varies widely within PSBs with a few banks benefitting from having built significant retained earnings over the years and a few with their stronger standalone profiles.

Ind-Ra estimates that at this projected growth PSBs still require a Tier-1 capital of INR1.2trn over FY17-FY19 including INR0.4trn in common equity tier 1 and INR0.71trn in Additional Tier-1 (AT1) bonds. The need for a pickup in AT1 market remains critical to managing the capital availability through the Basel-III transition. A mere INR180bn of AT1 bonds have been issued so far, with insurance and pension funds (which have the requisite liability profile and risk appetite to invest in these instruments) keeping away on account of regulatory hurdles and inadequate price discovery. Ind-Ra believes that barring a few large PSBs, most banks are looking to consolidate their balance sheets, reduce risk-weighted assets, and preserve capital.

Ind-Ra reviewed the ratings of large PSBs namely State Bank of India, Bank of Baroda, Canara Bank, IDBI Bank and Union Bank of India.

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