The plans of public sector banks (PSBs) in India to raise capital from private sources will not be sufficient to mitigate anticipated risks unless supplemented with additional capital support from the State, says Fitch Ratings.
Several large State-run banks have recently announced plans to raise a total of around $6 billion in fresh equity from the capital market.
According to Fitch, state-run banks are already facing significant execution risks in raising equity due to depressed stock market valuations and weak investor interest. A recent news report citing the government's plan to reduce the number of state banks to five from 12 while selling majority stakes in several others, including Bank of India to raise resources, could add to uncertainties.
It says, "A reduction in the state's majority shareholding in some of its banks may dent depositor confidence and potentially lead to negative rating action as their long-term ratings are anchored to state support. It may also reduce investor appetite at a time when government capital support has stuttered, and an acceleration in new coronavirus cases is hampering a meaningful economic recovery and increasing risks for banks' balance sheets."
"We believe the proposed stake sales will be very challenging in the current economic climate and in light of the potential capital shortfalls we calculate at the state banks in our stress test. It could also require amendments to the banking company acts, which currently prescribe a minimum government shareholding of 51% for the state banks, thus adding to execution risk," Fitch added.
The ratings agency says it expects PSBs in India will remain reliant on fresh equity injections from the state as the proposed capital amounts, if raised fully, will likely add only around 100-150 basis points (bps) to State banks' existing common equity tier-1 (CET1) ratios. It says, "Under our high stress scenario, this may provide some interim capital relief, testing the banks' ability to raise fresh equity on their own, but will not be enough to stave off heightened solvency risks. It would also increase the prospect of further regulatory forbearance."
Fitch says it believes recapitalisation requirements will be substantially higher once pandemic-related asset quality deterioration starts manifesting on bank balance sheets when regulatory forbearance ends, in which case raising equity from the market will be more difficult.
"Recent comments by the central bank governor highlighting the need for recapitalisation further underscores this imperative, emphasising the risks that deteriorating asset quality will pose to state banks' limited capital and earnings buffers. This is consistent with the outcome of our stress test on individual banks, whereby the state banks have significantly larger capital shortfalls than their private counterparts," the ratings agency added.
Indian private banks' recapitalisation requirements are comparatively more modest than their proposed fresh capital raising, with ICICI Bank Ltd and Axis Bank Ltd likely to add around 200bps-245bps to their existing CET1 ratios. This, according to Fitch, will further widen the capital gap between private and state banks, which, on average, is about 350bps.
Fitch says it believes ICICI Bank and Axis Bank—which have proposed plans to raise $2 billion each—will likely be encouraged by recent investor appetite for the almost $1 billion and $1.9 billion raised by Kotak Mahindra Bank and Yes Bank, respectively. Yes Bank was also recently supported through an injection of capital by the largest State-owned bank, State Bank of India (SBI), it added.