Despite Government’s attempt to reduce stake in state-owned banks, the public sector banks will continue to face capital challenges in the near future, according to Fitch Ratings.
The Government's plans to reduce its stake in state-owned banks to 52% by 2019 will make it easier for banks to raise capital in the equity market - by allowing the dilution of government holdings to raise core equity.
Fitch expects access to core equity to remain challenging, however, with state banks largely trading below book value. As such, state-owned banks will likely have to continue relying on Additional Tier 1 (AT1) hybrid instruments to strengthen capitalisation in the short term, despite the government's planned sell-downs,” Fitch said in a statement.
It added that there is no indication as yet that the government has planned this decision as part of a broader privatisation initiative in the banking sector, and Fitch believes that the government's stakes in state-owned banks is unlikely to go below 51% in the medium term.
So far, state banks have been slow in issuing AT1 capital, with only two issues of Rs 2,500 crore ($400mn) each - Bank of India in August 2014 and IDBI bank in October 2014. Combined, these two issues constitute roughly 5 per cent of the Fitch estimated total AT1 requirement through to 2016 affirming uncertainty on the ability of the domestic market on its own to fulfil the AT1 requirement of Indian banks.
Fitch estimates Indian banks to have Basel III capital needs to the tune of about Rs 12.47 lakh crore ($200 billion) up to 2019, of which state-owned banks will account for around 85 per cent. However, progress to strengthen capital has been slow, due to a low internal rate of capital accretion and limited access to core equity - owing to below-book valuations for many banks.
Asset quality pressures
Asset quality and earnings continue to remain stressed for most state banks notwithstanding some signs of early recovery. Expectations of higher restructuring in H2 FY15 and muted credit growth could further mean that earnings (and valuations) recovery will be slow and protracted. As such, the plan to reduce government stakes may have to wait until there is a meaningful recovery in earnings and, therefore, equity valuations.
State banks account for nearly 75 per cent of total banking system assets but hold 90 per cent of the system's stressed loans, with the stress on mid-sized state banks being particularly acute. By comparison, private banks are in a significantly stronger position than their state-owned peers in terms of capital and asset quality, Fitch said.