The government's Rs 881.39 billion capital infusion in struggling public sector banks (PSBs) should help in part to mitigate risks but resolution of bad assets and continued high credit costs hinder the sector's near-term performance, Fitch Ratings said on Thursday.
While the capital infusion plan was less than half of its estimate of $65 billion needed for the sector, Fitch said yesterday's announcement will encourage banks to resolve their non-performing loan (NPL) stock faster as improved capital buffers bolster their ability to absorb potential large haircuts.
Also, the additional capital buffers will enhance the banks' ability to raise equity capital.
The total amount is around 30 per cent of the state banks' equity base and is a significant shift away from the earlier drip-feed approach.
"It should go a long way in plugging the capital gap amid expectations of more haircuts and subdued earnings," it said.
Fitch said the capital infusion will stem the downward pressure on Viability Ratings (VRs), which have been downgraded several times over the last three to four years, and improve their access to capital markets which had been constrained due to poor health and weak valuations.
The decision to front-load around $12 billion through recapitalisation bonds would put banks in a slightly better position to absorb losses expected from resolution of NPLs.
The capital infusion "should help in part to mitigate the risks that Indian state banks face on account of weak asset quality and poor earnings," Fitch said.
But, unwinding of these risks will take some time, "implying that resolution of bad assets and continued high credit costs will hinder the sector's near-term performance," Fitch said maintaining its negative sector outlook to reflect these pressures.
It said the average core capitalisation for the state banks would be likely to reflect a cumulative increase of around 140 basis points.
Large, relatively better-positioned banks which are most capable of supporting growth, would receive a greater share of this first capital tranche, leading to a varying impact on capitalisation across banks, it said.
In contrast, private-sector banks' core capitalisation is better, with reasonable buffers, despite the deterioration in their asset quality.
Fitch expects the system's gross NPL ratio to increase to around 11.5 per cent in 2017-18 due to further slippages from various identified stressed pools, which will continue to dampen asset quality which is already weak.
"The pace of slippage should decline, while the system's weak provision cover ratio remains a key risk to capital," it said.
Fitch said the earnings of a number of state banks remain highly vulnerable, and some may report further losses from realisable values on bad loans being sharply lower than budgeted amounts.
In contrast, the earnings of private-sector banks have deteriorated significantly in recent years but still enjoy buffers that can withstand moderate amounts of stress.