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Basel-III norms may moderate banks' return on equity

Somasroy Chakraborty & Parnika Sokhi  |  Mumbai 

According to Crisil, banks may need to raise Rs 2.7 lakh cr for capital adequacy ratio.

Higher core equity capital requirements to meet proposed Basel III norms is likely to moderate Indian banks return on equity in coming quarters, industry analysts and bankers said. According to industry estimates return on equity of banks is expected to narrow by 150-180 basis points for incremental 100-120 basis points increase in core equity capital.

The draft guidelines on Basel III capital released by the Reserve Bank of India (RBI) last week proposed that core equity in tier I capital of banks should be increased to 5.5 per cent of risk weighted assets to improve the quality of capital. The central bank said the core equity should comprise of paid-up equity capital, share premium, statutory reserves, capital reserves, balance in profit and loss account at the end of the previous financial year, and any other disclosed free reserves.

"A combination of higher core equity, leverage ratio and phasing of inadmissible instruments is likely to moderate return on equity for public and private banks. Banks would need to be a lot more efficient in managing their capital structures in this environment," analysts with Kotak Institutional Securities said on Tuesday.(Click here for STATUS CHECK)

Their views were echoed by senior analysts with consultancy firms like Pricewater-houseCoopers (PwC) and Deloitte.

Analysts said Indian banks have maintained return on equity at around 15 per cent level in the past few years.

"This is likely to moderate. Raising additional capital will not be a major problem for most Indian banks as RBI has allowed some time to meet the new capital adequacy norms. But the real issue will be how banks will maintain their return on equity. The draft guidelines suggest that the core equity in tier I capital should be increased. If banks are not able to improve their profitability, it will weigh on them and impact their return on equity," said a senior analyst with a global consultancy firm.

RBI has also proposed that banks in India must maintain a capital conservation buffer in the form of common equity at 2.5 per cent of their risk weighted assets in addition to minimum capital adequacy ratio of 9 per cent.

"The guidelines seek to enhance the quality of capital for the banks. Common equity capital, that provides maximum loss absorption capacity will now double to a minimum of eight per cent from the current 3.6 per cent," Ramraj Pai, director at CRISIL Ratings, said.

According to the rating agency, banks in India have to raise around Rs 2.7 lakh crore between January 2013 to March 2017 to meet the new capital adequacy norms. Of these banks will need to raise Rs 1.4 lakh crore in the form of equity capital. "This requirement can turn out to be higher - by another Rs 1.3 lakh crore - in case the investor appetite is low for non-equity Tier-I capital instruments," Pawan Agrawal, director at CRISIL Ratings, said.

Bankers said that they will review the leverage ratios and send their feedback to RBI by February 15, 2012. However, most of them said that raising additional capital will not be an issue.

"I think no bank in India is taking a view that they should not be increasing their capital adequacy. I don't think Indian banks will face severe challenges on the capital front. There could be some challenges in the short-run because if the economy is growing then there will be credit growth and ultimately it will consume capital," KV Kamath, non-executive chairman of ICICI Bank, said.

Top officials of state-run banks said that they will need regular capital infusion from the government.

First Published: Wed, January 04 2012. 00:27 IST