As the crimson tide turns, a capital call

Buffeted by losses and provisioning, PSBs will need a top-up on the recapitalisation plan

India’s banking system, creaking under the weight of non-performing assets (NPAs) and capital provisioning thereof — which have led to steeped-in-crimson financials — is closer to a turnaround than before, but will need to scale another capital wall to reach there. Public sector banks (PSBs) will continue to need further capital infusion from the government. And that’s notwithstanding the improvements that we expect this fiscal: lower incremental slippages to NPAs, overall peaking out of NPAs, good recoveries from accounts referred to the National Company Law Tribunal(NCLT) for resolution under the Insolvency and Bankruptcy Code (IBC) process, and stabilising pre-provision profitability (PPoP).

Last fiscal, the banking system’s cost of provisioning for NPAs surged 58 per cent to Rs 3.5 trillion, compared to Rs 2.2 trillion a year earlier. That led to a loss of Rs 400 billion.

PSBs were worse off, because that cost was almost twice their PPoPs, and drove up a loss of Rs 850 billion, which has nearly obliterated the Rs 1.2 trillion capital raised by them last fiscal, including Rs 900 billion infused by the government.

To boot, the recall of Additional Tier I bonds by some PSBs also impacted capitalisation.

Given that provisioning would be high this fiscal too, mainly due to ageing of NPAs, many PSBs are on course to haemorrhage once again.

The upshot? PSBs would need more than the Rs 2.1 trillion recapitalisation announced by the government last fiscal.

The good part is that the course is changing, although slowly.

Systemic provision coverage ratio (PCR), or the capital that banks have to set aside as a percentage of their NPA stock, rose to 50 per cent (excluding write-offs)last fiscal — a six-year high — from 43 per cent in fiscal 2016, bulking up the cushion banks have. For PSBs, that number shot up from 41 per cent to 49 per cent.

On an aggregate basis, PCR increased substantially last fiscal and is expected to rise again this fiscal. Apart from higher provisioning due to ageing of NPAs, additional provisioning on stressed accounts referred to the NCLT under the IBC will continue to impact banks.

Fortunately, the NPA tide mark is only a quarter or two away. Gross NPAs had increased to 11.2 per cent of advances, or Rs 10.3 trillion, in fiscal 2018, compared to the 9.4 per cent in fiscal 2017; and should peak at 11.5 per cent this fiscal.

Impairment, mainly in the corporate loan books of banks coupled with the NPA recognition due to the Reserve Bank of India’s (RBI)revised framework for stressed assets resolution announced in February 2018 had led to Rs 5 trillion of loans turning NPAs last fiscal.

Today, there are three drivers to the turnaround in Indian banking.

First, incremental slippages to NPAs would be lower after peaking last fiscal —  with 85 per cent of the stressed loans already recognised — and improvement in corporate credit quality owing to firm commodity prices, stable macros, and better capital structure and debt protection metrics. 

Second, SMA-2 (or special mention accounts, where loans are overdue for 60-90 days) cases have reduced materially, which means stressed loans that had the potential to become NPAs have similarly declined.

Third is the expected resolution of large stressed accounts that compose almost half of the corporate NPAs under the IBC process. This would augment recoveries and help reduce NPAs. 

Additionally, some big stressed assets from the steel sector are reaching the penultimate phase of resolution.

More than a quarter of the Rs 3.3 trillion worth of cases referred to the NCLT for resolution is from the steel sector. Bidding interest has been good due to improving industry prospects.

With further strengthening of the IBC through the recent ordinance, timelines and realisations should also improve.

Additionally, PPoP, which was impacted by a rise in NPAs and sub-optimal credit growth, especially at PSBs, should stabilise this fiscal and gather pace thereafter.

This will be supported by higher net interest income stemming from improved credit growth and lower interest reversal owing to lesser slippages to NPAs. The step-up in credit growth will also help banks shore up their fee income.

Systemic PCR which has seen an uptrend in the last three fiscals will continue to rise going forward — moving from 50 per cent to 55 per cent in the current fiscal.

While the pincer movement of higher provisioning and losses have eroded the market valuation of PSBs and left them severely dependent on the government for capital, private sector banks are on a canter with comfortable capital ratios emanating from healthy accretions to networth. They also have demonstrated ability to raise equity and have better revenue diversity.

So while the turnaround in banking is, well, around the corner, shrinking capital at PSBs is once again becoming the elephant in the room.

The author is senior director, CRISIL Ratings