Lack of capital allocation for Indian state-owned banks in the Union Budget for FY2023 arguably indicates the government’s belief that their financials will remain healthy in the near term, enabling them to support capital adequacy by sourcing fresh capital on their own, according to Fitch Ratings.

The global rating agency observed that it does not regard this as signifying diminished prospects of extraordinary support from the government. Nonetheless, the modest capitalisation of State banks has been a key drag on their competitiveness, leading to a significant loss of market share over the past decade, it added.

Fitch noted that the government has injected close to $47 billion of fresh capital into its banks since the financial year ended 2015 (FY15), although most of this was used to address the large losses during this period, leaving core capital buffers at moderate-to-low levels and vulnerable to losses beyond the banks’ expectations.

Internal accruals

Improving internal accruals are gradually adding to the capital base, but the average common equity Tier 1 (CET1) ratio at State banks stood at 10.8 per cent at end-1HFY22, against 16.5 per cent at private banks, which have been reporting above-average loan growth in recent quarters.

“This may make it difficult for State banks to remain competitive, unless their capital raising efforts are supplemented by state capital injections. The State banks have raised around $3 billion cumulatively since 2020, or about 0.4 per cent of their risk-weighted assets,” the agency said in a report.

Fitch believes that Indian banks are less likely to need fresh core capital to meet the minimum regulatory capital requirements up to FYE25, as regulatory forbearance has enabled banks to spread related credit costs over a longer period, resulting in a more manageable impact on profitability and capital.

“There is a risk that state banks may use their modest capital accretion to support the government’s growth agenda, rather than keep it as insulation against losses when unrecognised bad loans start unwinding in FY23. Banks have been cautious thus far, focusing on retail loans and highly rated corporates that help limit risk density,” the agency said.

Fitch observed that growth momentum should average at about 7.0 per cent over the medium term. However, the government’s push towards infrastructure spending is an important driver that may be put at risk by the State banks’ risk aversion and limited lending potential, especially in the absence of sufficient depth in the local bond markets, it added.

Emergency credit

The agency opined that the extension of the government’s emergency credit loan guarantee scheme for micro, small and medium enterprises (MSME) to March 2023, from March 2022, and from ₹4.5-lakh crore to ₹5-lakh crore, is an indication of the incipient stress that is largely unrecognised due to restructuring, signalled by a plunge in MSME credit.

It emphasised that the risk of losses is high, with the segment’s aggregate impaired and special-mention (those overdue by up to 90 days) loans reported at 18.5 per cent and 14.9 per cent, respectively, for State banks, and 2.8 per cent and 9.3 per cent for the private banks as of September 2021.

The agency expects India’s real GDP growth to rebound to 8.4 per cent in FY22, from -7.3 per cent in FY21, boosted by a consumer-led recovery and the easing of supply disruption.

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