The report also predicts that bad loan issues that the banks face today may peak by this fiscal year. Gross bad loans of the system has crossed 10.2 per cent or Rs 10 trillion by the December quarter and RBI has warned that it will cross 11.1 per cent by the next September quarter.
Last October, government had announced a capital allocation plan for public sector banks to the tune of about Rs 2.1 trillion over the next two years. Of this Rs 181.3 billion will be met through budgetary provisions, and Rs 1.35 trillion through recapitalisation bonds.
"State-run banks' weak capital profile is their key credit weakness in comparison to their peers in the private sector. As of September 2017, average common equity tier 1 (CET1) ratio of the state-run lenders was 8.7 per cent compared to 12.2 per cent for private sector banks. But the gap is expected to narrow with the recapitalisation," Alka Anbarasu, a vice-president and senior analyst at global rating agency Moody's said in a note today.
She, however, did not quantify by how much the gap will narrow for the harried state-run banks.
The government will allocate the Rs 1.5 trillion capital across the 21 public sector banks so that they will all have (CET1 ratios above the minimum Basel III requirements of 8 per cent by the end of March 2019, it said.
Capital infusion will also help these lenders build their provision coverage ratios as they will be able to allocate much of their operating profit towards loan-loss provisions without having to worry about the impact on their capital positions," Anbarasu said.
She expects the banks to achieve an average provision coverage of 70 per cent by FY19, allowing them to take appropriate haircuts on problem assets.
With much greater visibility regarding their future receipt of adequate capital from government, it's possible that these banks may also regain market access, she said.
In the same report, Moody's domestic affiliate Icra said bad loans may peak by FY18, but elevated levels of provisioning on these bad loans will continue to negatively affect banks in FY18 and FY19.
Pace of fresh bad loan generation continues to moderate with an annualised rate of 3.9 per cent for the second quarter of FY18 as against an annualized 5 per cent for the first half and 5.5 per cent for FY17.
Icra estimates fresh slippages to grow by 3-4 per cent for FY18, which will translate into fresh slippages of Rs 2.5 -3 trillion, and after adjustments for recoveries/upgrades and write-offs, gross bad loans may increase to Rs 8.8-9 trillion or 10-10.2 per cent) by the end of FY18 compared to Rs 7.65 trillion or 9.5 per cent) in FY17.
"While gross bad loans are likely to peak by the end of FY18, the negative impact arising from elevated provisions for weak assets is likely to continue until FY19," Icra said.
The pace of NPA resolution has accelerated over the last six months with RBI directing banks to initiate proceedings under the Insolvency and Bankruptcy Code against stressed borrowers as well as make higher provisions on these stressed accounts.
Icra believes with one-third of gross bad loans already identified for resolution under the IBC, provisioning surged 40 per cent in the second quarter of FY18 sequentially and 30 per cent on an annual basis.
With public sector banks accounting for almost 88 per cent of total dud loans, the ability and willingness of these banks to resolve these stressed accounts has also improved following recapitalization announcement.
"We expect their credit provisions to surge to Rs 2.4 -2.6 trillion in FY18 against Rs 2 trillion in FY17. For public sector banks, provisions are estimated to increase to Rs 2-2.2 trillion in FY18 from Rs 1.6 trillion in FY17," Icra group head for financial sector ratings, Karthik Srinivasan said in the joint report.
With provisioning of state-run banks is significantly higher than core operating profitability, Icra estimates that their losses will spike manifold at Rs 300-400 billion in FY18 from Rs 70 billion in FY17.