Though the RBI has given banks a breather by extending the transitional period for full implementation of Basel III regulations by a year, credit rating agencies have warned that investors will seek higher coupons on their non-equity capital instruments.
Last week, the RBI decided to extend the implementation of Basel III capital regulations by a year to March 2019, thereby leading to lower capital requirements for banks in the interim.
According to Crisil Ratings, the extension of the transition period by a year will lead to reduction in capital requirements of banks by ₹40,000 crore up to March 2018 from an earlier estimate of ₹2.7 lakh crore.
However, the capital regulations also increase the risks in the banks’ Tier I capital instruments, and will lead to higher cost for banks.
Pawan Agrawal, Senior Director, Crisil Ratings, said, “This release of capital will enable banks to offset the impact of lower internal generation of capital due to the prevailing squeeze on their profitability in the current economic cycle.”
According to ICRA estimates, Tier I capital requirement of public sector banks to meet growth as well as Basel III norms would increase from ₹3.3-3.6 lakh crore to ₹3.9-4.2 lakh crore due to the longer transition period; while during FY2015-2018, the requirement would fall from ₹3.3-3.6 lakh crore to ₹2.8-3 lakh crore.
“As there is no relief on overall capital requirement on full implementation of Basel III norms, capital would remain a big challenge for PSBs,” the rating agency said.
However, the dependence on raising external capital will remain high, especially for public sector banks.
Key risksAccording to Crisil, the guidelines increase the cost of raising Tier I instruments for banks by introducing risk-mitigation features.
The first risk relates to the higher risk of coupon non-payment for investors arising from the stipulations that banks can pay coupon only out of current year’s profits (and not from retained earnings), and that the coupon payout be capped at 40 per cent of a bank’s total distributable surplus for the year.
The second risk is the increase in potential loss of principal due to the provision that disallows banks to opt for temporary write-down in the event of breach of pre-specified trigger.
In ICRA’s opinion investor appetite for permanent write-down feature could be low, this could result in fresh issuances of non-equity Tier I capital instruments only with the conversion feature.
A Fitch Ratings report said, “The flipside is that greater loss absorbency would come at the cost of being less investor-friendly. Tier 1 securities are expected to shoulder a large share of the capital burden and investor appetite is currently limited, adding to the capital raising challenges.”