Risks of servicing Basel II debt capital instruments have increased for several public sector banks due to their weak capital ratios.
Servicing of debt capital instruments under Basel II norms is contingent upon banks meeting tier 1 capital of 7 per cent and hence overall regulatory capital adequacy ratio (CAR) of 9 per cent.
Despite recapitalisation of the 15 PSBs that have declared results for FY18, tier 1 capital position reported by five – Oriental Bank of Commerce (7.61 per cent), Allahabad Bank (6.9 per cent), Central Bank of India (7.01 per cent), Andhra Bank (7.44 per cent), Punjab National Bank (7.12 per cent) – are closer to minimum regulatory requirement of 7 per cent.
The coupon servicing ability for these weak banks is now contingent on their ability to raise capital immediately before their coupon payment due dates.
According to rating agency Icra, as on April 1, 2018, PSBs had Rs 63,595 crore of such debt capital instruments. Of this, 11 banks, currently placed under the prompt corrective action framework of RBI, have issued Rs 25,831 crore.
Karthik Srinivasan, senior Icra vice-president, said: “Through the recapitalisation plan, Rs 90,000 crore of capital infusion has been done in FY18. But that this is less than sufficient got reflected after announcement of regulatory forbearances during the first week of April, which was intended to shore up their financial year-end reported capital ratios.
“Adjusted for regulatory forbearances allowing them to defer loss provisions by few quarters, the tier I capital could be lower than 7 per cent for some of these banks. The capital ratios will weaken for if they don’t raise capital immediately as banks will need to provide for these losses in their subsequent quarterly results.”
The capital position reflects a bank’s strength to absorb credit losses as well as the ability to grow loans and improve its profitability. However, strong capital position is also important to prevent default on its debt capital instruments.
The government’s plan to shore up PSBs capital position through Rs 2.11 lakh crore recapitalisation programme appears to have run into rough weather. PSBs were grappling with many issues due to haircuts on loans upon resolution, losses on bond portfolios and the early recall of additional tier 1 (AT-1) bonds.
Amid all this, the Rs 13000 crore fraud disclosed by Punjab National Bank (PNB) has led to sharp decline in share prices and has also spoiled PSBs’ plan to raise capital from the market. “The efficacy of the Rs 2.11 trillion recapitalisation programme stands considerably reduced as 27 per cent (Rs 560 billon) of the amount is contingent upon PSBs’ ability to raise capital from the markets,” said Icra.
According to an Icra research, six months after announcement in October 2017, the situation has become apparent with the announcement of regulatory forbearances in April. These forbearances include deferment of minimum provision on accounts referred under IBC by a quarter and; amortisation over four quarters of the mark-to-market losses on the bond portfolios suffered during H2FY18.
As for FY19, the timebound resolution of stressed accounts and recognition of NPAs are likely to accelerate following the announcement of the revised framework by RBI in February. This will lead to more losses for banks during FY19. Though the banks are likely to emerge with cleaner asset quality, Rs 65,000 crore of capital infusion budgeted by the government for FY19, may well turn out to be inadequate.
The ability of the PSBs to meet regulatory capital ratios and, consequently, their credit ratings, will remain highly dependent on them being able to raise capital from the markets.
If the banks are unable to raise capital from the market, the government will be required to augment its share of capital infusion in FY19.
“With expectations of elevated losses, the possibility of breaches of regulatory capital ratios for some PSBs in the interim reporting period cannot be ruled out. Though all PSBs placed under PCA framework have redeemed their AT-I bonds as on date, the servicing of some of the Basel II capital bonds while adhering to their covenants continues to be dependent on them meeting regulatory capital ratios.
If the weaker PSBs are unable to raise capital in a timely manner in FY19, it is going to be a credit negative for their ratings,” warned Srinivasan.